Where GDP goes, consumers follow.
Yesterday the Commerce Department reported that the U.S. economy grew at a 0.7% annualized rate in Q1, below estimates of 0.9%. There were some positive underlying trends within the report, but the market took this as a disappointment.
The bigger worry is that the GDP report and the University of Michigan’s Consumer Sentiment – which measures how people feel about the prospects of economic growth and their own budgets – track each other.
There is historically a strong correlation between GDP and sentiment. The chart below shows the consumer sentiment index against year-over-year real GDP growth since 2012.
Consumer confidence surged after the election of Donald Trump. But as we hit the 100 day mark of his presidency, the economy has little to show for this optimism. If the correlation with GDP holds, there could be a big correction in consumer sentiment ahead.
Beware the ides of Q1
People are generally optimistic about the state of the economy. In addition to the consumer sentiment index, Americans are as confident as ever in the state of their jobs and businesses. That’s according to a Gallup poll released this week:
“The current 8% of full- or part-time employees who say they are “very” or “fairly” likely to be laid off in the next 12 months is, by one percentage point, the lowest Gallup has recorded since first asking the question in 1975.”
The economy needs people to feel confident so that people are willing to take on long-term mortgages, start businesses, or buy capital to expand an existing business. Positive sentiment and optimism can be a virtuous cycle. If people feel good, then they can will the economy forward.
There is a danger, however. As the Milwaukee Journal Sentinel recently reported, political cheerleading plays a big part into the perceived performance of the economy. People are not only fitting the evidence o to their own preferences, they are mentally changing the evidence to fit that narrative as well (note, supporters of both political parties do this, according to the chart above). If the economy doesn’t grow, then there is bound to be a lot of disappointment, given the lofty expectations.
Economic optimism still plays a part in today’s economy. But will optimism and positive vibes about the economy translate into real growth?