Perspective matters in all facets of daily life, and events both major (parenthood) and minor (a traffic jam) can change how a person sees the world. This is particularly true when analyzing economic and financial market data. At present, an array of datapoints suggests the U.S. economy is slowing down. However, zooming out and adopting a longer-term perspective leads to a different conclusion: the economy remains healthy and is instead normalizing from a period of elevated growth following the recovery from the COVID-19 pandemic.
One example where a longer-term perspective leads to a different conclusion comes from the manufacturing sector. The headline ISM Manufacturing PMI survey provides insight into the evolution of the business cycle broadly and manufacturing activity specifically. After reaching its highest level (64.0) in nearly three decades in 2021, this survey slipped into contractionary territory (below 50) by late 2022 and remained there for over a year.
Investors with a short-term perspective might observe that the ISM Manufacturing PMI has been soft for over a year and contracted again during the second quarter after briefly expanding in March, a concerning development. However, investors with a longer-term perspective might instead conclude that the ISM’s bottoming process is rarely smooth, and that an upward reversal is the historical norm once a bottom has formed. Further, the ISM didn’t drop below the mid-40s during past soft landings, similar to 2023.
A second area where perspective can impact an investor’s conclusion is around newly delinquent debt, or the share of consumers starting to fall behind on loan payments. Delinquency rates have been on the rise since late 2021, with categories such as autos and credit cards surpassing their pre-pandemic levels. This leads to the worry that consumer financial health is deteriorating, and that consumption could slow as individuals are forced to retrench.
However, much of the deterioration comes specifically from loans issued in 2020 and 2021, when many previously subprime borrowers were in healthier financial shape given stimulus payments, loan and rent forbearance programs and strong low-income wage gains. More recently issued debt is not seeing the same dynamic with regard to delinquencies and, more importantly, the growth in delinquency rates peaked in 2023. Many bank management teams expect delinquency rates to plateau in the coming quarters, an encouraging sign supported by the latest data, which shows incrementally slower growth in newly delinquent loans. Finally, a longer-term perspective shows that delinquency rates are largely still in-line with pre-pandemic levels and, despite their recent march higher, are not yet in troubled territory. Through this lens, the headwind to consumption should be somewhat limited.
Lower-income consumers are the most likely to fall behind on their debts. However, we are seeing some positive developments: the lowest-earning Americans (measured in quintiles) have seen the strongest wage gains over the past few years, up 31% since the onset of the pandemic, while inflation (CPI) has risen just 19.4%. This has helped support their spending even in the face of the increased cost of day-to-day living. While this group remains under pressure, it accounts for less than 10% of overall consumption. In fact, the bottom three quintiles (60%) of the income spectrum combined account for as much spending as the top quintile (20%) alone.
While wages for higher-income cohorts haven’t risen substantially faster than inflation over the past few years, these individuals have benefited from wealth effects with financial markets and home prices seeing considerable appreciation. Combined with lower debt loads, this cohort is in a position to offset any weakness in spending by lower-income consumers and help keep the economy expanding.
Much of the outsize wage gain for lower-income Americans came during the reopening from the pandemic when finding workers was perhaps the largest challenge facing many employers. High wages, receding pandemic risks and strong immigration have all helped to boost labor supply, all of which has occurred more recently against a backdrop of moderating labor demand. The result has been more modest wage gains over the past two years.
Ultimately, we believe that a longer-term perspective on macro data shows that the destination the economy is headed for is the one many believed was the most likely outcome two to three years ago — a return to normal. It just took a little longer to get there.
Jeffrey Schulze, CFA, is Director, Head of Economic and Market Strategy at ClearBridge Investments, a subsidiary of Franklin Templeton. His predictions are not intended to be relied upon as a forecast of actual future events or performance or investment advice. Past performance is no guarantee of future returns. Neither ClearBridge Investments nor its information providers are responsible for any damages or losses arising from any use of this information.
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