How The U.S. Consumer Could Bail Out The Stock Market

There is a bright spot amid mounting investor concerns that a looming U.S. economic slowdown could trigger a bear market. The cause for optimism is strong consumer spending, which accounts for about two thirds of U.S. economic activity. "Three of the key drivers of consumer spending send a positive message for the near-term outlook," Goldman Sachs analysts write in a recent research note, as quoted by CNBC.

Goldman has a bullish outlook for U.S. stocks in 2019, with a base case of 3,000 on the S&P 500 Index (SPX) and an upside case of 3,400 by year-end. These figures would represent gains of 13% and 28%, respectively, from Wednesday's close. An economy buoyed by consumer spending is a powerful driver that could sustain corporate earnings growth and bolster stocks, which are being buffeted by rising interest rates, trade wars and forecasts of slowing earnings and GDP growth.

Goldman forecasts that consumer spending will grow at an annual rate of 2.7% in both 2018 and 2019, before settling down to 2.0% growth in 2020, per the firm's US Weekly Kickstart report. They project that consumer spending will be more robust than the U.S. economy as a whole, given that they expect GDP growth to slow to 2.5% in 2019 and to 1.6% in 2020.

There are three reasons why Goldman is upbeat about consumer spending, per the research note quoted by CNBC:

"First, real disposable income [i.e., after taxes and adjusted for inflation] is likely to continue its strong growth due to accelerating wage growth, and recent declines in the oil price are likely to be a significant tailwind to spending in 2019." Goldman projects that the unemployment rate will continue to fall from 3.8% in 2018 to 3.2% in 2019 and 3.1% in 2019, which should continue to push up wages, giving consumers more money to spend on electronics, entertainment, apparel, food and other items. Federal income tax cuts are another factor contributing to rising disposable income in 2018.

"Second, the savings rate looks elevated relative to the high level of household wealth, even after the recent sell-off." Personal savings as a percentage of disposable income was 6.2% in October, the most recent month for which data is available, having ranged from 6.2% to 7.4% since January 2017, per the U.S. Bureau of Economic Analysis.

Third, "consumer sentiment is likely to stay elevated, reflecting strong underlying economic fundamentals as well as optimism about the labor market and income growth." The Index of Consumer Sentiment stands at 97.5 in December, up by 1.7% from a year ago, per the University of Michigan. Their report notes that the monthly index has been above 90 since January 2017, its longest stretch at this level since 1997-2000.

Retail sales look especially strong. Excluding autos and gasoline, they are on track to rise by 4.9% in 2018, up from 4.2% in 2017, which would be the biggest annual increase in seven years, per Kiplinger. The same report estimates that sales growth will decelerate in 2019, but still be a robust 4%. Meanwhile, analysts at Edward Jones have predicted that holiday season sales in 2018 will be up by 5% from the same period in 2017, a year over year increase that would be above the five-year average, as previously discussed by Investopedia.

While robust consumer spending is positive for the economy and stocks, a number of negatives could undermine them. One is the risk of an expanding trade war with China that could boost prices of U.S. goods while slowing employment and wage growth in key industries. Already, hikes in interest rates are raising costs to consumers and businesses alike, crimping corporate profit margins. These forces, which are growing, already have turned many investors bearish.