Global Macro Strategy

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

July 19, 2016

Michael Taylor, CFA®, Global Research Analyst

“It’s the Economy, Stupid…Really”

  • The Misery Index is an unofficial index that often is used to gauge voters’ perception of the domestic economy.
  • Inflation has remained muted and unemployment has improved significantly since the financial crisis.

What it may mean for investors

  • The economy is top of mind of many voters as we head into the 2016 election season. We expect the U.S. economy to continue expanding, albeit gradually.

In 1992, the Clinton campaign stressed how important the economy is to voters with a simple-yet-powerful slogan—“it’s the economy, stupid.” At the time, Americans had just spent 12 years with Republicans in the White House and were coming off a recession. Twelve years earlier, Ronald Reagan asked voters if they were better off than four years prior, financially speaking. Today, voters are grappling with a host of issues from health care and immigration reform to dissatisfaction with Washington, and, of course, the economy. As the Republican National Convention convenes in Cleveland this week and Democrats meet in Philadelphia next week, voters, particularly undecided ones, are evaluating what’s important to them in a candidate.

A recent poll from the Pew Research Center found that 84 percent of registered voters consider the economy a “very important issue” to the 2016 vote, four points above terrorism and 10 points over immigration reform.

Chart 1. Top Issues for Voters in 2016Chart 1. Top Issues for Voters in 2016Source: Pew Research, June 2016.

If the economy is a key factor in shaping voter opinion, how do voters assess the state of the U.S. economy? Or put another way, what factors influence the perception of the current economic situation for voters? One such indicator that often appears in the press before major elections is the Misery Index. This gauge combines the unemployment and inflation rates, two influences that largely impact consumers’ sentiment about the economy—and interestingly, the two key mandates the Federal Reserve uses to steer monetary policy. Since 1977, the Misery Index peaked near the end of the Carter administration when inflation skyrocketed, and declined significantly during the Reagan years. The positive performance for most of the 1980s may help to explain why the Republicans controlled the White House until 1992. More recently, the index climbed late in George W. Bush’s second term mainly due to job losses following the financial crisis, and may help to explain the 2008 election outcome. During President Obama’s two terms in office, the index gradually has been declining owing to low inflation and an improving employment situation.

Chart 2. U.S. Misery Index (Inflation and Unemployment)Chart 2. U.S. Misery Index (Inflation and Unemployment)Source: Bloomberg, 7/16/16.

Today, inflation is relatively subdued, and unemployment is low. On Friday, the Consumer Price Index (CPI) increased 0.2 percent, and core inflation (which excludes food and energy components) also rose by 0.2 percent. Meanwhile, the U.S. labor market continues to strengthen. The U.S. economy added 2.7 million jobs last year, and the growth trend continues. Job growth rebounded last month after a disappointing May number, and the unemployment rate for June was 4.9 percent. Wages are increasing modestly, although real wage growth (adjusted for inflation) remains mostly flat for many workers. Additionally, the number of workers applying for unemployment benefits is easing from 2009 highs. Initial jobless claims (seasonally-adjusted) have remained below 300,000 for 71 consecutive weeks—the longest stretch since 1973.

Besides inflation and unemployment, there are other factors that may influence voter perception of economic conditions. Since consumer spending comprises nearly 70 percent of the U.S. economy, consumer sentiment and activity also are important indicators of voter perception of the economy. In June, consumer confidence exceeded expectations by a wide margin, underscoring the general optimism among consumers. Retail sales have been trending higher, rising 0.5 percent in May and 0.6 percent in June, indicating that consumer spending has been picking up. Yet, neither has returned to pre-crisis levels.

The housing sector is another important driver of economic growth, and home affordability is an influential factor for many voters. The U.S. housing sector has been a beacon of economic growth in recent years, and we expect the trend to continue for some time. Housing starts for June increased 4.8 percent and building permits rose 1.5 percent over May’s figures, reinforcing this upbeat trend. Home prices continue to make modest gains. A healthy housing sector contributes to the so-called “wealth effect,” a powerful behavioral perception that helps to bolster consumer sentiment and spending.

Economic Implications

This year’s presidential election is shaping up to be a spirited contest, bolstered by a perpetual flow of troubling headlines and negative attack ads. Although these sensational messages occasionally can rattle voters’ emotions, polls suggest that the economy should play a prominent role in shaping voter opinion for November’s election. Many voters are evaluating which candidate will be most beneficial for future economic prospects and their individual livelihood. For now, the U.S. economy appears on solid ground and continues to expand gradually. We expect the U.S. economy to grow about two percent this year. Inflation and unemployment rates should remain modest, at 1.4 percent and 4.8 percent respectively. Whether it is a Clinton victory or a Trump victory, the outcome likely will not have an immediate effect on the U.S. economic landscape.

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