Upbeat consumers may sustain U.S. as firms hesitate

Consumers in the U.S. are stepping in where companies fear to tread.

Americans are more upbeat while business sentiment stagnates, a sign their spending will provide a bridge for the economic expansion until the so-called fiscal cliff is resolved and entices companies to resume investment.

“In the tug-of-war between more confident consumers and more cautious businesses, it looks like the consumer is winning,” said Harm Bandholz, chief U.S. economist at UniCredit Group in New York. “It puts a floor under growth. With consumer spending rising at even a moderate pace, the expansion will carry on.”

The re-election of President Barack Obama yesterday helps remove one element of uncertainty about the nation’s direction as the focus shifts to how lawmakers approach the fiscal cliff – $607 billion in federal tax increases and spending cuts slated for next year. For consumers, rising home prices, an improving job market and healthier finances are trumping those concerns, making it more likely household demand will be sustained.

Household optimism is the highest in more than four years, reports from the Conference Board and Thomson Reuters/University of Michigan show, while a Bloomberg gauge of confidence in the economy is the strongest since early 2008. Corporate sentiment has stalled, according to Institute for Supply Management measures that underscore a cautionary tone from company officials on earnings calls.

Americans are also gaining enough confidence to take on more debt. Consumer credit increased more than forecast in September, led by a pickup in borrowing for education and automobiles, Federal Reserve figures showed today (Nov. 7) in Washington.

Kimball International Inc., a Jasper, Ind.-based maker of furniture and electronics, is among companies that see the potential for a pickup in business investment if the fiscal cliff is avoided.

Demand among clients is “quite strong” for commissioning projects and seeking quotations on price and design, said Chief Executive Officer James Thyen. Still, “we’re seeing hesitancy in our customers to actually enter the order.”

“Once the election season is over and the fiscal cliff is addressed, we could start to see more of a pickup in the hospitality market,” Thyen said on a Nov. 1 conference call with analysts. He said an estimated 700,000 hotel rooms in the industry are 11 to 15 years old and “due for refurbishment.”

Eaton Corp., a Cleveland-based maker of industrial equipment and vehicle powertrain systems, is also counting on a rebound in demand when a more conducive political environment allows businesses to resume the investment they’ve postponed.

“We’ve seen people speak explicitly about not placing orders until they see how things come out here at year-end,” Alexander Cutler, CEO, said on an Oct. 31 earnings call.
A bipartisan agreement on the fiscal cliff means “business confidence will improve fairly rapidly,” he said. “It is not necessary that all of the cuts be affected in one year or that all of the revenue rates be affected. But there has to be a plan that’s credible.”

Companies are also holding back on investment as global demand cools. The European Commission said the euro-area economy will virtually grind to a halt next year as the debt crisis ravages southern Europe and gnaws at the economic performance of export-driven Germany.

For now, U.S. businesses are choosing to hunker down. Corporate spending on equipment and software was little changed in the third quarter, the weakest in three years. The ISM’s factory index, a proxy for sentiment, was 51.7 in October after 51.5 the prior month. It has been hovering above 50 – the dividing line between expansion and contraction – after shrinking in June, July and August.

“Consumers, if they have money in hand, are typically less willing to give up consumption of goods and services in anticipation of bad things down the road,” said Dean Maki, New York-based chief U.S. economist for Barclays Plc and a former Federal Reserve researcher. “Business spending is very sensitive. Companies will hold off on that large capital project until they’re certain it won’t be a waste.”

Consumers are getting a lift from improving job prospects and a nascent housing-market recovery that is bolstering household balance sheets.

Employers added 171,000 workers to payrolls in October, more than forecast and up from a gain of 148,000 in October, the Labor Department reported on Nov. 2. The S&P/Case-Shiller index of property values in 20 cities rose 2% in August from a year earlier, the biggest gain since July 2010.

The Conference Board’s consumer confidence index increased in October to the highest level since February 2008, while the Michigan sentiment gauge reached the highest since September 2007, before the last recession began. The Bloomberg Consumer Comfort survey’s index of the state of the economy had the best showing since March 2008, according to data for the week ended Oct. 28.

Improved confidence is encouraging consumers to spend. Retail sales in September and August had the best back-to-back showing since late 2010 as shoppers snapped up goods from cars to Apple Inc.’s iPhones. Automobiles and light trucks sold at a 14.9 million annual pace in September, the strongest since March 2008, according to Ward’s Automotive Group.

Household purchases, which make up about 70% of the economy, accelerated to a 2% annual rate in the third quarter. Economic growth came in at a stronger-than-forecast 2% pace, up from a 1.3% gain.

While it’s likely that the fiscal cliff will be avoided, there’s a risk of an outcome that could reduce disposable incomes enough to prompt consumers to retrench, even as companies hold back on investment, said UniCredit’s Bandholz. And even with optimism on the rise, households will find it hard to step up spending without a pickup in wage growth, he said.