Why U.S. stock markets may reflect too much optimism about consumer spending, heading into what could be a subdued year-end shopping season.
Chief Investment Officer, Wealth Management
U.S. consumers have a lot on their minds recently, weighed down by the coronavirus Delta variant, a more-sluggish-than-expected jobs recovery, inflation worries and the spectacle of political wrangling in Washington, D.C. At the same time, financial markets seem to be “climbing a wall of worry,” confident that these growing anxieties about inflation, supply-chain disruptions and the economic drag from the pandemic will soon pass.
We believe the consumer perspective warrants attention. Negative sentiment, especially heading into the year-end holiday season, could presage market weakness, catalyzed by lower-than-expected spending and disappointing corporate earnings.
Let’s first consider that consumer confidence and stock market moves have historically been well correlated; any notable divergences tend to be short-lived. But today, the gap between the two remains uncharacteristically wide. On the consumer side, the Conference Board’s confidence index fell in September for the third straight month, with the gauges of current and future conditions at 5- and 10-month lows, amid lingering concerns over higher prices and a slow job-market recovery. Note that job growth stalled again in September, missing estimates and signaling that the forces holding back hiring or returning to the workforce may persist.
At the same time, investors’ “buy the dip” mentality, anchored by a belief that inflation is transitory and corporate margins will be sustainable, has bolstered the stock market. U.S. equities did hit a rough patch in the third quarter, but the downturn was contained to within 5% of the pre-Labor Day highs, and advances so far in October suggest that the third-quarter speedbumps may now be behind us.
Still, are investors overly optimistic, and how can their market views be so disconnected from consumers’ outlook? We see two key factors behind the split:
- Investors appear less worried about inflation than consumers. Markets are pegging inflation expectations around 2.5%, while consumers anticipate prices rising 4.6%, according to a recent University of Michigan survey, more in line with August’s readings of 5.3% for the consumer-price index and 4.3% for the personal consumption expenditures deflator. Note that, while the Fed and markets may view inflation as transitory, consumers often see rising prices—especially for things like energy, rent and food—as reason to curb discretionary spending.
- Investors and consumers seem to be interpreting supply-chain disruptions differently. Based on the resilience we’re seeing in corporate earnings revisions, investors appear confident that inventory shortages stemming from supply-chain troubles will simply delay, rather than destroy, demand. But for consumers, the lack of inventory may actually mean that they can’t find what they want at prices they can afford—or at all. This helps explain why real personal spending is growing at less than 1% annually, well below the historical trend, and why the savings rate, at 9.4%, remains well above average.
In short, financial markets are pricing a scenario where inflation is transitory, corporate pricing power can preserve profits and policy tussles in Washington remain a sideshow. Consumers appear to be anticipating a very different situation—one where inflation proves sticky and weighs on real wage and income growth, supply-chain disruptions eventually lead to lost consumption and policy uncertainty keeps consumer spending low and savings high.
Of the two, we are weighting the consumer perspective more heavily because inflationary conditions likely will last longer, posing greater risks to corporate earnings forecasts, especially if consumer sentiment translates into lower spending. Investors should pay close attention to whether consumer sentiment and market metrics reconverge. Given the different potential year-end economic scenarios—stronger growth vs. economic slowdown—we think that investors might want to consider cutting passive index exposure in favor of the barbell approach, with cyclicals on one end and defensive stocks on the other.
This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Oct 11, 2021, “Mind the (Confidence) Gap.”