Continually, I monitor the consumer to see what will happen with the overall economy. The consumer is the main driving force of the economy, representing over 70% of the entire economy. And, consumer expenditures start the demand cycle. The way our economy is devised we are a demand economy, not a command economy where an outside entity dictates what is produced. Businesses respond to the wants and needs of the consumer. The driving factor in all of this is, of course, the consumer responds to its personal incomes and the growth or contraction of personal incomes.
Given that, the backdrop of the consumer right now is high inflation and low wage growth. The consumer is taxed considerably. And, when viewed from all-time highs on savings rate declines, the consumer is taking on different approaches simply to get by. If you look at what the consumer is spending money on there is a shift away from wants to basic needs. Some products are going without while others are getting the lion’s share of expenditures.
Here is a rundown of the charts I am looking at that encapsulates the current consumer disposition.
The rate of growth of personal incomes largely determines the rate of growth of expenditures in the economy. From this, the demand cycle either expands or contracts given the correlation between incomes and the economy. While the correlation is far from a perfect 1.00, the correlation is very strong.
As you can see in the chart above from the BEA.gov website, incomes have not reached normal levels yet on a year-over-year basis.bea.gov For now, personal incomes continue to be hindered on a real basis; meaning, inflation adjusted. If incomes cannot keep up with inflation, consumption will be dampened. But, mostly Americans are having to spend what they do not earn in the form of savings decline (Below).
Expenditures have been declining and starting to move below baseline expenditure levels from prior to the pandemic. Should the rate of growth of expenditures move below the pre-pandemic levels, this will begin the process of a contracting economy. Interestingly, the Bureau of Economic Analysis has already printed two consecutive quarters of negative growth in the economy via the GDP. Economic activity is declining.
Should the consumer’s consumption rate continue lower, this will push the economy further lower. Keep in mind the Federal Reserve is in the process of moderating demand because of inflation. Inflation rates are at 40-year highs.
However, it is important to note that the Federal Reserve has stated their position now is that they are data-dependent. Because of this, the Fed may not raise interest rates after this year, after hitting an approximate 3.25% – 3.50% short term interest rate level.
PCE Inflation Rate
The culprit of all of this is demand pull inflation. The rate of growth of prices has elevated to 40-year highs. But, the worst may be over; the growth rate may stop increasing. From here, prices, should they mellow out at lower levels, will be able to settle closer to normalized growth rates. But, in order for the economy to truly catch up, incomes need to catch up. This will be a difficult task given that the Fed is trying to dampen demand and lower the employment rate.
The metric of Retail Sales encompasses food expenditures and gas purchases at gas stations. So, the fact that this metric is lofted above levels from prep-pandemic levels should not be thought of as an improvement seeing that gas and food bills have pushed to all-time highs. Instead, this should be looked at as it is: Retail sales have been elevated owed to higher inflation rates.
University of Michigan Consumer Sentiment
If you want to know how the consumer is feeling, the University of Michigan consumer sentiment index is a great place to start. The consumer hit an all-time low last month. This month’s numbers barely moved upward. Perhaps this is the worst of it and, the consumer sees that from this point forward there can only be an improvement. That does not mean that the consumer is all of a sudden going to start exploding with expenditures and the economy will roar back to life. It means exactly what it sounds like it means: the consumer feels the very worst is over. But, the consumer is not feeling rosy overall; just that the worst is over.
Consumers are having to dip into their savings in order to keep up. But, not all Americans have a savings to rely upon. 75% of Americans have less than $1,000.00 in savings and 50% have zero. 65% are living from paycheck to paycheck. The vast majority of individuals are merely getting by, and they are having to forego some expenditures for others. Should the savings rate continue lower, with an eventuality that it declines entirely, this will stop at some point as the savings rate declines downward closer to lower levels not seen in decades.
How does this play out in the Stock Market?
What is the bottom line? Growth rates are going to slow down as interest rate increases take their effect over time. The consumer, while the rate of growth of consumption will decline because of a virtual tax on the consumer, unemployment is likely to head higher. The decline in consumption will mean that the eventuality is for revenues at businesses to decline. We are already seeing that. But, the correlation between declining revenues and profits has not manifested in lower stock moves. Investors are more focused on the fact that the Fed is likely to sit on its hands at the end of this year.
That is where I begin to caution on this: The Fed sitting on its hands does not mean that the stock market will head higher. The Fed is sitting on its hands at a rate where it believes that the level of accommodation is neither expansionary nor contractionary. But, unemployment will have to move lower in order to ultimately tame inflation. Then, incomes need to catch up.
Any moves higher in the stock market at this point are not a solid buying opportunity but, a level at which I believe will be the price to sell from. The stock market will continue lower.