Signs of consumer stress are beginning to surface as uncertainty grows over when the Federal Reserve will cut interest rates from a 23-year high. If these signs persist, the stock market may be in trouble.
Beginning as early as March, investors anticipated six quarter percentage point rate cuts in 2024. Rather, investors sharply reduced their expectations, factoring in only two to three cuts starting in the fall due to sticky inflation readings, a tight labor market, and other data.
Although there was a dip in stock prices in April, investors mostly accepted the change, with stocks supported by expectations that growing profits would come from a robust consumer and economic environment. On the other hand, consumers are now displaying more discretion in their purchases. Last week, a number of companies reported weak first-quarter sales growth, including Wendy’s WEN, +0.10%, McDonald’s MCD, -1.08%, Shake Shack SHAK, +2.41%, Starbucks SBUX, -2.43%, and Yum Brands, the parent company of KFC, YUM, -0.54%.
According to Mace McCain, chief investment officer of Frost Investment Advisors, recent data indicates that while consumer incomes and spending are still rising, the fact that consumer spending is outpacing income suggests greater stress.
“We would keep an eye on the rise in unemployment.” According to McCain, “because consumers would usually pull back if unemployment and job insecurity started to rise.” McCain stated, “We’ll be keeping an eye on the jobs data to see when that stress actually translates into consumers spending less and slowing the economy.”
The U.S. jobs growth in April was less robust than anticipated, according to data released last Friday. Only 175,000 new jobs were created by the economy last month, a six-month low. Economists had predicted a 240,000 rise in employment. In contrast, the unemployment rate increased slightly to 3.9% from 3.8%, making it less than 4% for the 27th consecutive month.
But those numbers didn’t raise any red flags. Rather, as investors projected a “Goldilocks” scenario—where the economy is neither too hot nor too cold—that Fed policymakers would likely embrace, stocks increased.
Gregory Daco, chief economist at EY, described the data as “encouraging” over the phone. The overall jobs report suggests that the labor market is still in the process of readjusting. Thus, labor demand is moderate, employment rates are historically low, and wage growth is slowing down in the current environment. That combination is perfect.
McCain said that the jobs report supports data indicating a slight labor weakness accompanied by slower growth, which might permit the Fed to continue reducing interest rates.
US stocks had a better week’s end. According to Dow Jones Market Data, the Dow Jones Industrial Average DJIA increased by 436.02 points, or 1.1%, during the week to close at 38675.68. The Nasdaq Composite COMP increased by 228.43 points, or 1.4%, to close the week at 16156.33, while the S&P 500 SPX gained 27.83 points, or 0.6%, to close at 5127.79.
Some strike more forcefully than others.
Chief investment officer of Moneyfarm Richard Flax says the strain on consumers has affected some businesses but not the overall stock market.
According to Flax in a call, different demographic cohorts have been impacted by higher interest rates in different ways, with those with lower incomes being hit particularly hard. “Americans with lower incomes make up a smaller but still significant portion of the country’s consumer base. Thus, some but not all of their earnings are impacted by their stress, Flax stated in a call.
McCain of Frost Investment reiterated the idea. “The economy is currently quite divided. McCain stated, “The top half is doing significantly better than the bottom half.”
According to McCain, homeowners who were unable to secure mortgage rates between 3% and 4% are under the greatest stress. However, McCain pointed out that those with the greatest incomes and wealth are spending at a healthy rate due to the continued high cost of housing and the stock market’s positive returns.
“As inflation remains relatively high, there is growing risk for the Federal Reserve in the form of distress among lower-class households,” according to Flax. He went on, “That’s not a traditional stagflation metric; perhaps it’s an inequality metric.”
Investors can anticipate remarks this week from Fed Governor Lisa Cook, President John Williams of the New York Fed, and President Tom Barkin of the Richmond Fed.
On Wednesday, Thursday, and Friday, respectively, data on wholesale inventories, weekly initial jobless claims, and consumer sentiment are due.
