Consumer Sentiment Plummets To All-Time Low – Expect More Selling

University of Michigan Consumer Sentiment index came in for June at 50.  This is an all-time low.  This portends future selling in the stock market ahead.  Consumer Sentiment is a leading indicator showing what is likely to unfold in an economy.  When you put the pieces together you can easily see that there is far, far more selling to go in the broader stock market despite steep 20% declines already.

Despite the bad news, the Stock Market, the broader market rallied.  The reason for that is simple.  The Federal Reserve is very likely to have to slow its pace of raising interest rates, if not stop altogether.  That will remain to be seen as to how it plays out.  But, the stock market rallied sharply on the dire news and seized upon the notion that interest rates are not going higher too much more.

What is University of Michigan Consumer Sentiment Index?

First, what is the University of Michigan Consumer Sentiment Index? As the name implies, the index measures the sentiment of how consumers are feeling at any given moment.  And, considering that the sentiment indicator hit an all-time low, we can conclude that consumers have never felt so poorly about future expectations.

Keep in mind, this sentiment index, although it encompasses data since 1990, it includes the Great Recession when the financial crises loomed so large.  And yet, consumers feel more uncertain today than at any time in the past.

Why is Consumer Sentiment Bad?

There is a direct correlation between consumer sentiment and consumer expenditures.  Therefore, one can expect that consumer expenditures will decline sharply moving forward.

Usually, I look toward the rate of growth of personal incomes to determine what is likely to occur moving forward with the economy.  If the rate of growth of personal incomes increases or decreases, then expenditures, which have a very strong correlation to the rate of growth of incomes, will move up or down.

If personal incomes are increasing at a rate greater than inflation then, by extension, personal expenditures will follow.  Increases in personal expenditures drive the demand curve.  Businesses will respond with hiring individuals and increasing supply.

Personal Income & Consumer Sentiment

But, there is also a direct correlation between personal incomes and sentiment.  And, if you think that through, it is easy to see why.  If personal incomes are increasing at an annual rate above the inflation rate then consumers will see this and feel more certain about their respective future.

That added certainty is found within the comparison of personal income growth and consumer sentiment index, a fairly direct correlation.  The three indicators, personal incomes, and consumer expenditures & consumer sentiment go fairly hand-in-hand.

Inflation and Consumer Sentiment

One thing that is important to point out is that personal incomes are being eaten away at by excessively high inflation.  The inflation numbers are seeping into everyday life in many ways.

Food and gas prices are at very high levels.  And, rent is cutting into many Americans’ lives.

But, all the while, real personal incomes have stagnated.  So, while prices at the leaping higher at a very fast rate, the ability to keep up with incomes is being eaten away at via the high levels of inflation.

This has led to all-time lows in sentiment.

The thing about corporate profits…

Personal incomes are stagnant.  Inflation is high.  Sentiment is low.  What does this translate into?

Personal incomes drive the demand cycle for businesses as I have discussed many times.  If personal incomes are being eaten away, consumers will entrench and spend less on other items outside of normal expenditures such as every day life items like food, gas, rent, and immediate necessities.

Because consumers are going to spend less, businesses will see less profits in the future.

Businesses have yet to see effects

Businesses have yet to really start the process of cutting back on inventory needs or personnel.  But, with a shrinking rate of demand for products and services, this is a matter of when.

And, the historical drop in consumer sentiment will mean a sharp decline in business revenue, and by extension, profits.

The Last Part of Q2

We have already seen a decline in Q1 of revenue for companies as well as GDP in general.  When you correlate the decline in personal income with the increase in inflation, as well as the decline in consumer sentiment, you can see that Q1 was just the beginning.

Q1, of course, entailed January, February, and March.  And, companies reported revenue declines all throughout April, May, and June for the first three months of the year.

Now, we are seeing an even sharper decline with income and sentiment during an even sharper increase in inflation, in the last part of June.  Companies will not report this information for a couple more months, mostly during the month of July and August.

Expect company revenues to decline even more

Just as consumer sentiment is declining, so will revenue during this quarter. But, this is not the bottom of the contraction but, the beginning of a longer trend that may take several months, if not several quarters, to play out.

Because of this, an investor could simultaneously expect even further declines during Q3 as a possible tsunami of losses will ensue.

Stocks May Decline an Additional 10% – 20%

Being on the cusp of such a sharp decline in revenues, the stock market will adjust to this.  Revenues for companies will decline sharply; profits, even more so.  And, the next step will be employment declines as companies cut costs across the board.

There will be a bottoming.  And, that is on the horizon.  However, that future bottom is way out in the distance.

For now, the stock market has sold off sharply over the medium term.  Most recently, there has been a relief bounce.  And, it may be that there is more buying as investors buy this dip looking to make profits as they can.

But, the eventuality will be that when companies start to print ever increasing declines, stock valuations will have to have to adjust; we are no where near the bottom.

Possible silver lining

If there is a potential takeaway, it would be that the Federal Reserve will be forced to stop raising interest rates.  In an economy that is contracting quickly, inflation will dissipate on its own.

In the meantime, look for stocks to take a hit in August and September as Q2 numbers start to show up.  And, if inflation keeps heading higher, this will also have an effect on what might happen from Q2 results.  But, my general thinking is that the numbers for Q2 are going to be bad with sharp declines in revenue and profits.  This will pull the market downward.  And, it may be a big move downward.