Page 6 - ISQ July 2022

INVESTMENT STRATEGY QUARTERLY

GDP = C + I + G + (X – M)

Personal Gross Private Domestic
Consumption Investment (I)
Expenditures (C) • Residential Investments
• Durable Goods • Non-residential Investments
• Non-durable Goods • Change in Inventories
• Services

Government
Consumption Net Exports (X – M)
and Gross Investment (G) • Exports
• Gross Investments • Imports
• Federal
• State & Local

is by far the largest one of the four, accounting for approximately While consumption is the largest contributor to GDP, gross
~70% of GDP. So what drives consumer spending? Employment is private domestic investments is the component that tends to
arguably the biggest factor behind personal consumption. be a harbinger of future economic growth. Recessions do not
In fact, as people earn a steady stream of income, they tend to start with the consumer, but rather with a slowdown or a
keep consuming. At the time of this writing, the unemployment decline in private investments. When the economic outlook
rate stands at 3.6%, and there are over 11 million jobs available deteriorates, companies tend to decrease their investments to
(almost one for every two unemployed people). Therefore, the weather a potential storm. One of the first indications of a
labour market continues to be strong, and unless this changes change of heart by firms comes as an increase in the
significantly, it should not negatively impact spending. accumulation of inventories. As inventories accumulate over a
typical level, they first start to adjust their purchase/production.
Another factor is consumer confidence, which indicates future Thereafter, they start to lay off workers, slow down or
expectations of the consumer; and, while it’s been on a downward temporarily halt hiring, and stop or postpone the purchase of
trend, it’s still above its 30-year average. Lastly, interest rates and machinery and equipment, and so on to reduce spending.
prices have a big impact on consumers. The first makes consumers
choose between present and future consumption. That is, as THE WEALTH EFFECT MISCONCEPTION
interest rates increase, consumers tend to postpone current Western populations, particularly the most wealthy, have seen
consumption for higher consumption in the future. However, their net worth surge significantly since the pandemic began,
since interest rate increases have not translated into much higher but the truth is, most people don’t live off their net worth. While
rates paid on savings, it is unlikely that consumers are going to experiencing an increase in net worth puts a consumer’s mind
postpone current consumption for future consumption.
more at ease when purchasing big-ticket items, for most people,
Meanwhile, higher prices reduce the purchasing power of income from their jobs remains the most important factor. The
incomes and thus puts downward pressure on consumption. good news is that across the various income quintiles, most
However, the accumulation of savings during the pandemic incomes are higher than they were prior to the pandemic, and
seems to be keeping consumers in the consumption lane for the even more important, they increased more than what we
time being.

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