Consumers Spending and Investors Sentiment

It would seem logical to anticipate a close correlation between consumer spending and stock market sentiment. As consumers increase their spending, and especially wealthy consumers, the stock market would presumably rally. The assumption is based on the knowledge that consumer spending represents 66% of the US GDP, more sales lead to more profits, and, ultimately, rising stock values. Conversely, as consumers slow their spending, the stock market weakens or potentially sinks into a correction, a decline of 20% from its previous high.

Last week, the University of Michigan released its Consumer Sentiment Index, indicating the index declined 1.8 points to 67.7 in the preliminary September report following August’s adjusted index reading of 69.5. Consumers have not recovered in sentiment even close to their pre-pandemic high levels of confidence. However, consumer sentiment has steadily improved since May 2022 as individuals and businesses seem to be adjusting to the new interest rate environment.

The pre-pandemic years of 2016 to 2020 logged the best consumer sentiment index levels during this century. However, as good as these years were for consumers, the index was easily surpassed by the 1996 to 2000 years. However, once the impact of coronavirus spread around the world in 2020, consumer sentiment dropped to ten-year lows. Surprisingly, sentiment improved by mid-2020, even with worldwide draconian government regulations on people and businesses, supply and labor disruptions, and new working standards. However, optimism began to dissipate by the end of 2021, and then consumer sentiment plummeted to its lowest reading in history by mid-2022 as the Fed implemented the needed but painful aggressive rate increase policy to reverse a quickly developing hyper-inflation economy.

As mentioned, one would assume that as consumers’ sentiment rises, so would the stock market. However, as the Consumer Sentiment index was dropping to new all-time lows in 2020, it was also a unique time in which the S&P 500 rallied a cumulative 47.5% in 2020 and 2021. It was a remarkable time in which investors realized that even though consumer sentiment dropped due to the circumstances in America and around the world, their spending levels would remain the same. In fact, the stock market underestimated consumers’ financial resiliency as they exceeded spending expectations due to the trifecta benefit of high employment, ultra-low interest rates, and trillions of dollars in government subsidies.

The below chart illustrates the S&P 500 (orange line) to the Consumer Sentiment Index (purple line). Prior to 2020, the S&P 500 correlated with consumer sentiment, rising and falling in tandem. However, Consumer Sentiment plummeted in 2020 as the S&P 500 rallied to new all-time highs. We would attribute this disconnect as an anomaly due to unprecedented events of ultra-low interest rates along with the distribution to nearly all Americans trillions in government subsidies.

Since July 31, the S&P 500 declined 6% to a year low on August 18, followed by a mild recovery that has morphed into a flat channel trend holding at its 20 and 50-day Moving Averages (DMA).

We have mentioned the importance of a reasonable holiday retail sales season this year for continued economic growth and a rising stock market. Last year, holiday sales experienced a slight increase over 2021. A concern in 2021 was the steady decline of consumer sentiment beginning in the summer that continued through the holiday season. The principal change in sentiment can be directly attributed to a significant rise in interest rates. The mild increase in holiday sales was disappointing but anticipated. This year, sentiment has again started trending down since its year-high peak in July, during a time when the Federal Reserve paused its rate hike campaign.

Yesterday, CNBC reported that 92% of Americans surveyed have reduced their spending in the past six months. The poll is very current and conducted by Morning Consult, surveying 4403 individuals from last Tuesday to Thursday. CNBC opined the following regarding this report:

“Consumers remain cautious in their spending, and they’re being more discerning about where and when to part with hard-earned cash. Inflation has come down but remains stubbornly high. Broader economic uncertainty and labor unrest, amid striking auto workers in Detroit and writers and actors in Hollywood, have put consumer companies on watch."

“The most common categories for spending cuts over the past six months were clothing and apparel (63%), restaurants and bars (62%), and entertainment outside the house (56%), a pattern that held steady from our June survey. The next biggest categories for cuts were groceries (54%), recreational travel and vacations (53%), and electronics (50%.)”.

The trend of declining consumer spending may continue again into this holiday season. In the same report, CNBC noted,

“More than half (55%) of households earning $50,000 or less (lower-income) said they’re feeling the impact of the economy on their personal finances, while 61% of households $50,000 to $100,000 (middle-income) and 46% of households making at least $100,000 (higher-income) reported the same.”

WHAT DOES IT MEAN TO ME?

The stock market has an amazing track record of identifying changing trends, sometimes a year in advance.
Since July, the S&P 500 has flat-lined, which could be interrupted as institutional profit taking from a strong first-half-year rally. It could also be an indication that institutional investors are concerned about a slowing economy or if the Fed can indeed slow inflation without driving the economy into a recession. The “soft landing” scenario of raising rates to lower inflation to near 2% annual increases while not stifling economic growth is a delicate process. The challenge of managing an economic soft landing involves many other factors unrelated to whether the economy can absorb higher loan costs. Rising unemployment, foreign manufacturing disruptions, war, new government regulations and tax laws, and higher energy prices are all unrelated factors that can slow the economy or, combined, can be the impetus to reversing economic growth into a recession.

We will be monitoring all these issues and reporting them to you as they develop. Give us a call if you have any comments on this Weekly Brief. This is a terrific time to call us to discuss your financial planning and determine if you are prepared for retirement.