Consumption Junction

Soaring Now Soured?

Are small business owners having second thoughts? The latest National Federation of Independent Business (NFIP) Optimism Index unexpectedly fell. President Trump’s plans for deregulation and lower taxes flipped a switch after the election among small business owners. The survey had a gigantic 8-point spike in November and Sales Expectations, suffering a 34-month string of negative readings, suddenly reversed faster than at any other time in the survey’s 40-year history. Now, reality may have set in. The survey reflected the fact that there has been no improvement in actual sales since the election, and January saw further weakness.

Importantly, buying ahead of tariffs appears over, and soft consumer demand could be behind this change. December saw an emphatic inventory buildup before the tariff deadline. This month, there was a large drop in inventory buying plans, revealing that businesses are now more concerned about declining future sales than adding to inventories before prices rise more.

Stock investors initially latched onto the positive benefits of lower taxes and deregulation, which take longer to implement than the relatively quick but economically harmful measures of tariffs and immigration. That lag creates a window for investor optimism to reverse. Small business optimism took a pause after looking at a weaker consumer; we believe investors could be close behind. In that case, we are ready to turn defensive, especially if a strong equity rally unfolds into month end, stretching valuations.

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No Laughing Matter

The NFIB survey of small businesses showing sagging sales are describing a symptom, not the disease. Two Federal Reserve banks published disturbing data that provided reasons for the poor revenues. The New York Federal Reserve’s Quarterly Report on Household Debt and Credit last week reported that the percentage of households delinquent beyond 90 days on auto and credit card loans reached the highest level since 2011. The Philadelphia Fed reported that one out of every ten credit card owners are paying the minimum amount, a 12-year high. Consumers are spending more, which is seen as a positive, but they are paying less of their debt off, and card balances have increased more than 50% over the last three years.

With the labor market solid, overall delinquency rates are low at 3.5%, so why panic? If unemployment rises further, the many Americans living paycheck-to-paycheck are also vulnerable to defaulting on their loans. Companies have not been hiring, so those who have lost their jobs have been unable to return to the workforce. If firms accelerate layoffs, defaults will inevitably increase.

This is why employment is a coincident indicator—historically, it is always strong right into every business slowdown. When enough people get laid off, the economy quickly turns, and a recession ensues.

Banks could realize that the latest increase in defaults can be the start of something worse and may tighten their lending standards. If credit is harder to obtain, then the current sales slowdown in the NFIB survey and the monthly drop in January Retail Sales can get even worse. If that scenario unfolds, it could create a hair-trigger effect of rising unemployment. This puts us on alert to watch retail sales data more closely. For now, the time is for raised awareness to avoid being caught at the top, but not yet a time to raise cash.

China Must Start Eating Itself

China once again is faced with a dilemma. There is renewed optimism for the economy after the government finally injected capital into property developer China Vanke. However, because China’s economy is based on manufacturing exports, tariffs could cut demand for the country’s products, trapping those goods within the country’s borders. Consumption will not be able to increase sufficiently to absorb the excess supply, so deflation is likely to worsen. That would be unfortunate because investors have been bidding up equities hoping that the China Vanke news could help housing and mark the end of the country’s worst deflationary period in 60 years.

There was a burst of homebuying that came after last September’s major Communist Party meeting, but demand faded because the Party hesitated to address the root problem of directly capitalizing on ailing developers. Our hope is that at the next big meeting in March, the Party will commit to more of the stimulus that helped China Vanke.

Optimism may have already turned, and Chinese stocks have outperformed U.S. equities so far in 2025. This is only a blip in a 15-year period of underperformance, but it is a start. Due to the long-term nature of strengthening Chinese consumers’ demand, we need to continue tracking Chinese stocks relative to U.S. indices over the long run for continued signs of confidence. If news hits that China is planning to move manufacturing to the U.S. to avoid tariffs, that will certainly generate an immediate upward spike in Chinese and U.S. stock markets, but it is the price action occurring in the weeks following such an announcement that matters more.

What to Look for This Week

1. Wednesday, February 19 at 2:00 p.m. E.S.T. Minutes of the January 28-29 FOMC Meeting. This could be the most insightful report out this week if there is light shed on why the first paragraph of the January FOMC omitting the phrase: “Inflation has made progress toward the Committee’s 2 percent objective” in the December statement to simply read “Inflation remains somewhat elevated.”

2. Thursday, February 20 at 8:30 a.m. E.S.T. Philadelphia Fed Manufacturing Survey for February. This series exploded higher in January driven by strength in New Orders and Capex. We will see whether this survey had the same reversal that we saw in the NFIB survey.

3. Friday, February 21 at 10:00 a.m. E.S.T. University of Michigan Consumer Survey Final Survey. Of particular importance will be if Michigan 5-year Inflation Expectations stay extremely high at 3.3%, as was reflected in the preliminary survey. 

FOMC Voters Speaking: Monday had Fed Governor Waller tell an Australian audience he expects tariffs to have a modest and temporary inflection effect that the Fed “can ignore in setting rate policy”. Fed Governor Bowman’s speech Monday was more cautionary, saying high yields on longer maturity Treasuries are based on inflation concerns stemming from the worry that the Fed has not raised rates enough. Fed Governor Barr speaks on Artificial intelligence on Tuesday, February 18 at 1:00 p.m. E.S.T. and again at 2:30 p.m. on Thursday, February 20. Vice Chair Jefferson speaks Wednesday, February 19 at 5:00 p.m. E.S.T. and again on Frida,y February 21 at 11:30 a.m. E.S.T. Neither speaker should move markets. A potentially interesting event is Governor Kugler discussion about inflation after markets close on Thursday, February 20 at 5:00 p.m. E.S.T.