One of the most common plotlines in all of literature is when a protagonist, overestimating the gravity of a situation, responds with a series of unfortunate decisions. Perhaps the classic example of this is Romeo, not appreciating the difference between a sleeping Juliet and a dead Juliet, but the pattern has played out in innumerable stories.
When it comes to the state of the economy, it seems clear that Americans are harboring too negative a view. In the short run, this misapprehension may not lead to disaster. However, it could still imperil investment returns if it leads to political decisions that make a relatively healthy economy sick.
Recent polls show Americans remain in an extraordinarily gloomy mood. The University of Michigan consumer sentiment index for May came in at just 69.1, lower than 84% of the readings since 1978. An April Gallup poll showed just 23% of respondents were satisfied with the way things were going in the United States compared to 74% who were dissatisfied, a wider negative gap than three-quarters of the time since they started asking this question in the late 1970s. Finally, a Harris poll, released last week, showed that 72% of Americans thought inflation was increasing, 56% believed the economy was in recession, 49% thought the stock market had fallen over the past year and 49% thought that unemployment was at a 50-year high, perceptions that are all factually incorrect.
But why are Americans so gloomy about the economy and what implications does this have for investing, both in the short run and in the long run?
Why the Gloom?
First, it should be acknowledged that Americans are more gloomy about the economy than would be suggested by the economic statistics that have traditionally driven economic attitudes. A simple regression model, estimated between January 1978 and December 2019, can explain 67% of the variance in consumer sentiment as a function of the unemployment rate and year-over-year changes in consumer prices, the S&P500, payroll employment, gasoline prices, home prices and wages. The standard error of the regression is 7.3 index points – that is to say roughly two-thirds of the actual observations were within 7.3 points of what the model predicted. Applying this model to our expectations of economic data for May 2024 suggests an index reading of 97.2 – the actual number, as I mentioned, came in at 69.1 – almost four standard errors lower than the model predicted. A similar analysis of the factors explaining the Conference Board’s consumer confidence index suggests a reading of 122.7 should be reported for May on Tuesday – however we now believe that the number will come in at 96.5 – in this case more than two standard errors below the model’s prediction.
But if economic confidence is much lower than can be explained by all these economic variables, what else could be causing the decline[1]?
One possibility is that Americans just feel gloomier about their own personal lives. This could make sense based on research on the impact of smart phones on mental health[2], particularly among young people, or the impact of long covid on public health or just the isolation triggered by the pandemic. However, a January Gallup survey showed that 78% of people expressed satisfaction with their personal lives, only marginally below the 83% average since 1979. By contrast, in January, just 23% expressed satisfaction with how things were going in the U.S. far below the 37% average for that question over the same period.
A second possibility is that growing income inequality may be leading to greater dissatisfaction. It should be emphasized that in surveys of consumers, unlike data on personal income and spending, each individual is equally important. So, even if the economy is humming along because of the income and spending of the most affluent households, most families could still feel that they were languishing.
The inequality argument is plausible since recent data[3] show that, based on tax returns, the top 10% of households had an even larger share of pre-tax income after the pandemic than in the years leading up to it. Rents are also still absorbing a higher share of disposable income than before the pandemic, which is clearly an additional burden on the 34% of U.S. households that rent, rather than own, a home. However, it should be recognized that income inequality has been rising since the 1980s and that, for more than a year, real wage growth has been positive on a year-over-year basis. Moreover, even after accounting for the inflation of the last few years, real wages for production and non-supervisory workers are modestly higher than they were before the pandemic.
So, even if a continued rise in inequality is having some depressing effect on consumer confidence, there is probably more to the story, and the Harris poll, which I cited earlier, suggests an answer. It is rather depressing that in a democracy the average voter is so ill-informed as to the actual state of the U.S. economy. However, it is easy to see how we got here. Over the decades, Americans have generally moved away from watching the evening news or reading newspapers, migrating to cable news shows with political bias on both sides and various online feeds with even greater political bias. Economic statistics are rarely covered while the public is increasingly bombarded with a long string of stories to be worried or angry about. Indeed, one of the most striking charts in our Guide to the Markets is page 68 which shows that self-identified Republicans and Democrats express a violent and almost instantaneous switch in how they perceive the current state of the economy when there is a change in the party controlling the White House.
The Consequences of the Gloom
Regardless of the causes of consumer gloom, it looks unlikely to lift anytime soon. Some marginal improvement in economic numbers is, of course, possible, particularly when it comes to inflation. However, there is little reason to believe that inequality will diminish or that Americas will suddenly begin to consume economic news from sources that are less toxically partisan, less negative and more informative. But if a depressed consumer is likely to be part of the economic landscape going forward, what implications does this have for investors?
First, it is unlikely to trigger recession. Confidence will likely stay higher among more affluent consumers who are more important for overall spending. In addition, experience of previous slumps in sentiment suggest that a confidence decline, that is not accompanied by actual increases in unemployment and declines in income and credit, has little impact in reducing spending. Consumer caution, if it translated into business caution, could lead to a decline in investment spending and hiring. Here the data are more mixed. The Conference Board’s Measure of CEO Confidence, show about average levels of confidence relative to the last 24 years. However, small business owners, polled by the National Federation of Independent Business, report more negative views relative to history. Even here, however, small business owners are more positive about their own business in areas such as hiring, earnings and capital spending, and more negative in more nebulous concepts such as the general outlook for business conditions, whether it is a good time to expand and future sales and credit conditions. On balance, we don’t expect this business caution to cause a slowdown.
However, business caution could cause employers to take a tougher stance on wage negotiations while Americans’ generally negative view of the economy could soften wage demands. This certainly seems to be the case over the past two years, with year-over-year gains in average hourly earnings falling from a peak of 5.9% in May 2022 to just 3.9% last month. If this persists, it may well be that general economic pessimism actually extends the soft landing by cooling the inflationary impact of a very tight labor market.
That being said, investors should be wary of another impact of a general perception that we are in economic crisis, namely, the potential for this perception to trigger bad policy decisions. Uninformed negativity makes voters easy prey for self-interested populists. Britain’s very unfortunate decision to leave the European Union in 2016 could ascribed to just such an effect. The embrace of tariffs by both political parties in the United States, despite strong evidence that they raise prices and slow economic growth, is another. The idea that the U.S. budget deficit can be controlled just by eliminating waste, fraud and abuse and without touching taxes, social security, defense or Medicare is similarly misinformed. And, while no-one can defend the chaotic state of migration at the U.S. southern border, the view that all immigration hurts rather than helps an economy seems similarly misguided.
For investors, the long-term danger is that overly-negative and misinformed voters vote for change but change in the wrong direction. The obvious investment implication is to diversify around the world and to include investments in countries where unreasonable pessimism is less likely to end in self-destructive policies.
[1] It should be noted that one interesting, although relatively minor factor, in the University of Michigan Survey is an on-going switch in survey techniques from phone interviews to online interviews. Parallel surveys conducted over the past seven years suggest that a full move to online surveys, which will be completed by the July survey, could reduce the consumer sentiment index by 6.6 index points – consumers are apparently more gloomy when filling out on-line surveys than when responding to a person on the other end of a phone line. This transition was half implemented in the May survey, potentially reducing the measured index by 3.3 points.
[2] See The Anxious Generation Jonathan Haidt, 2024
[3] See Income Inequality in the United States, 1913-1998, Quarterly Journal of Economics, 2003, Emmanuel Saez and Thomas Piketty, with data updated through 2022, March 2024,