• INDICATOR: April Durable Goods Orders and May Consumer Sentiment
• KEY DATA: Orders: -1.7%; Excluding Aircraft: +1%; Capital Spending: 1%/ Sentiment: -0.8%
• IN A NUTSHELL: “Business investment is improving, though it is hard to say it is booming.”

WHAT IT MEANS: The key to the strength of the economy over the next two years is the extent to which both businesses and households spend the tax cuts. Today, we got an indication that businesses are spending more on capital goods, though how much more is a real question. Durable goods orders fell in April, but largely because Boeings orders, which do bounce around, were off. Excluding commercial and defense aircraft orders, the demand for big-ticket items was up sharply. Of the major non-aircraft categories, only machinery declined. The number in this report that is most closely watched is the nondefense, non-aircraft capital goods orders category. This represents private sector capital spending the best and it jumped. Over the year, capital spending is up 6.6%, which looks good on the surface. But total durable goods orders have increased by 9.6%, so we cannot say that business investment is leading the way. Still, backlogs are building and that bodes well for future production.

Meanwhile, consumer confidence seems to have plateaued. The University of Michigan’s Consumer Sentiment Index dropped in May, which was a bit of a surprise. The reason for the decline was a deterioration in the view of current economic conditions. While the current economic conditions component is still at a high level, it is essentially back to where it was a year ago. Despite the tax cuts, the report stated that “consumers anticipated smaller income gains than a month or year ago”. It looks like workers don’t think the tax cuts will do a whole lot for their spending power.

MARKETS AND FED POLICY IMPLICATIONS: If you tune out the political noise, which is pretty difficult, you find that the economy is in good shape but there is little reason to think that growth is accelerating sharply. And now we have to deal with rising energy costs, which for lower and middle-income households, is wiping out a large portion of their tax cuts. That doesn’t bode well for consumption going forward. Businesses are spending more, but not enough. Given the huge tax cuts in the tax bill, anything less than double-digit increases in private, non-aircraft orders would be a major disappointment. If gasoline prices stay up, it will likely take a double-digit increase in investment to get us to 3% growth this year. The rise in interest rates will start squeezing homebuyers and those with variable rate loans. And this is an even numbered year and Congress is up for grabs. Already, the ugly campaign ads are appearing and they will reach a crescendo in the fall. That could depress confidence further. So, while the economy is in good shape, I am just not sure how long we can sustain 3% growth, which seems to be the benchmark. That is something investors might want to consider.

Joel L. Naroff is the president and founder of Naroff Economic Advisors, a strategic economic consulting firm.