Executive Summary
High interest rates and inflation have given the consumer pause. The University of Michigan Consumer Sentiment Index plunged 13% last month. The current reading suggests a recession is likely. Consumers, hit with high prices, have cut back on savings and ramped up their use of credit cards. Rates on credit cards over 20% are causing much pain. Spending habits are changing as witnessed by the drop in same store sales at Starbucks. Necessities are taking a priority over $7 lattes. Despite this, speculators continue to push valuations back to levels only seen 0.3% of the time. The gap now from the mean would require a 62% drop in the S&P 500, just to return to the mean. It is safe to say that consumers are concerned, but speculators are ignoring the lessons of the past. Please see The Details for more information.
Please continue to The Details for more of my analysis.
“Inflation is like toothpaste. Once it’s out, you can hardly get it back in again.”
–Karl Pohl
The Details
Last week I showed how the Conference Board’s Leading Economic Index was screaming “recession.” It seems the consumer is beginning to feel the impact of inflation and higher interest rates, as consumer sentiment plunged last month and is also flashing a recession warning. See the graph below of the University of Michigan Consumer Sentiment Index from Advisor Perspectives.
The director of the University of Michigan survey, Joanne Hsu, stated the following:
“Consumer sentiment retreated about 13% this May following three consecutive months of very little change. This 10 index-point decline is statistically significant and brings sentiment to its lowest reading in about six months. This month’s trend in sentiment is characterized by a broad consensus across consumers, with decreases across age, income, and education groups. Consumers in western states exhibited a particularly steep drop. While consumers have been reserving judgment for the past few months, they now perceive negative developments on a number of dimensions. They expressed worries that inflation, unemployment and interest rates may all be moving in an unfavorable direction in the year ahead.”
The drop in sentiment makes sense when looking at the drop in the personal savings rate (in red) and the surge in total personal debt (blue line) in the graph below.
Consumers are facing record high credit card balances which are being hit with interest rates over 20%. The increase in prices is eating away their ability to save money. This is being witnessed by the coffee indicator. Last week Starbucks announced disappointing earnings as same store sales dropped 3%. It appears consumers are making choices, and necessities are winning over $7 lattes.
Meanwhile speculators have led stock prices higher this year creating even more downside risk. The graph below of the Crestmont Price-to-Earnings Ratio (a derivation of the Shiller P/E) from Advisor Perspectives shows valuations over three standard deviations from the mean. In English, a rise in valuations this far from the average occurs less than 0.3% of the time. In order to bring valuations back to the mean, the S&P 500 would have to drop 62%. A drop below the mean would require an even greater fall. However, speculators don’t seem to care and are ignoring all lessons from the past. More on this topic in a future newsletter.
It is obvious consumers are becoming concerned about the economy. Don’t be confused by the behavior of speculators in the stock market. The majority of economic indicators are flashing warnings signs. Speculators would do well to take note.
The S&P 500 Index closed at 5,223, up 1.5% for the week. The yield on the 10-year Treasury Note remained at 4.50%. Oil prices remained at $78 per barrel, and the national average price of gasoline according to AAA fell to $3.62 per gallon.
© 2023. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.
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