Stocks Breaking Records As the Consumer Breaks?

Canary Eats Kitty

We were given a harsh reminder last week that the wealth gap is very much alive. Since the pandemic, the overall level of wealth has risen, but liquid assets, which drive consumption, are on a path that is somehow lower than if the pandemic and all the government transfers to consumers had never happened. We had a flashback to the high times of 2021 as Roaring Kitty re-emerged on social media and sparked a mini craze in the meme stock GameStop (GME), and a few others, including AMC, who rode on its coattails. However, speculators are literally spent, and the wave was short-lived. Profit takers appeared after two days and a mere 4x increase in GME, with the stock price peaking at Tuesday’s open. It then dropped from 65 to 20 into Friday after its earnings disappointment. Many speculators who got caught holding the bag in 2021 decided to cash out sooner rather than be the last one left buying, driving the stock back down. But the moral of the story is not that greed has been vanquished, but that the same people who drove the stock frenzy in 2021 have spent the government pandemic checks and extended unemployment benefits.

In 2021, real excess wealth, as measured by San Francisco Fed economists, peaked in late 2021 and helped fuel the binge-buying of meme stocks. Real wealth fell over the next year as equity markets sold off and inflation eroded the value of all assets. Even though stocks rose substantially from their October 2022 lows, the bottom half of Americans continued to spend their pandemic savings, which is basically down to zero. Net excess wealth from the pandemic is a thing of the past. The lesson from last week is that the small investor has no bullets left to continue chasing after lottery tickets such as GME because they are swamped with paying insurance bills, rent, and groceries.

Gimme Two Steps…

Whereas the average consumer is seeing their excess liquidity run out, stocks made new highs as the CPI report provided relief that the Fed will be cutting rates soon and providing liquidity. The general view from the Fed is that inflation is continuing its path to 2%, but the confidence in that forecast is lower because of high Q1 inflation. Investors are looking through the Fed speak and assuming that a better CPI means confidence in lower inflation has returned and rate cuts are on the way.

Inflation in services prices is what will keep the Fed from cutting rates, and even in this weaker-than-feared CPI report, insurance and rent inflation remain persistent. The clearest path to the market’s two-cut forecast is if wage inflation slows, but this may become a “be careful what you wish for” situation because a weakening consumer that is hit with softer pay could pull back hard on spending. At that point, the Fed would be cutting rates to try to salvage the economy rather than easing thanks to contained price inflation. For now, the prospects of rate cuts encourage more stock buying, but in the case of a weakening economy, that demand would evaporate and turn into selling.

Bostic Speaks the Truth

Retail Sales fell below consensus, and prior months were revised down, painting a portrait of a compromised consumer, a marked reversal from last year’s late spending surge. Looking at the details, we will be on the lookout for e-commerce sales data next month, as it was weak in April after 75% of March retail sales strength was driven by online sales. Gasoline sales pushed the headline number up, but spending more at the pump is not an encouraging factor for future spending. The trifecta of dwindling pandemic savings, softer real income growth, and growing worker concern over the labor market all point to a difficult environment for consumer-facing businesses.

Atlanta Fed President Raphael Bostic expressed his concern after speaking to regional business leaders who told him they are unable to fully pass through increased input costs to their consumers. Supporting his claims, the National Federation of Independent Business (NFIB) April Business Trends report revealed that 74% of small businesses were not going to raise prices, a one-year high. The deteriorating consumer outlook is not confined to small ticket items and may be affecting residential construction. April building permits, the most stable of the housing series data, mimicked retail sales by dropping below expectations and were also downwardly revised. From the April nonfarm payroll report, construction employment fell to its lowest level in over a year, and we will look quite closely at the May number when it is released on June 7. Any contraction would be an early warning sign for the economy.

What to Look for This Week

1. NVIDIA earnings are released on Tuesday May 22 after the market close.  The data itself will be critical, but the investor reaction to the earnings numbers and outlook, along with the earnings call will lend critical insight into general equity market trends.

2. On Thursday at 11:00 am E.S.T. the Kansas City Fed releases its May Composite Index. Two weeks ago, it released its Labor Market Conditions Index, which has been slowing steadily since last summer. The Composite Index measures manufacturing activity, and it will have our attention after the weakness in last week’s Philadelphia and Empire regional manufacturing surveys.

3.Influential FOMC Fed voter Governor Christopher Waller speaks Monday, May 20, at a U.S. Dollar conference. He did not comment on monetary policy when he spoke this Friday, so he may give his views before markets open at 9 am E.S.T. today. He speaks on the economic outlook 24 hours later Tuesday, May 21, and will certainly focus on his monetary policy views.