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Where the market sees signs of breaking point in consumer inflation

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A big question on the minds of Wall Street and C-suites across corporate America is consumer strength, namely, how long can it last?

At some point, consumers will begin to balk at higher prices brought on by demand shocks, supply chain disruptions and soaring energy prices. But they haven’t done it yet. So far, businesses have been able to pass on higher costs and consumers have been willing to pay. Higher wages, confidence in the job market, and the historically high American savings rate that has yet to be fully tapped are all contributing to the current economic strength.

The latest data from early earnings reports is encouraging. General Mills’ quarterly results last week showed no signs of consumers looking to “turn down” supermarket shelves.

“If General Mills is any indication, it’s fine,” said Stifel analyst Chris Growe. “I don’t want to exaggerate, but their performance in the last quarter was solid, relative to expectations, and their forecast was even better.”

According to Stifel’s analysis, double-digit price increases in its latest quarter, along with cost savings, will more than offset inflation for the company.

“There are so many prices ahead (up nearly 11% in the month of February for our large-cap food companies) that they will actually be enough to offset inflation,” Growe said. “There is a growing degree of relatively short-term confidence around this price/cost equilibrium taking hold.”

But how long this situation will last as good for earnings and portfolios is on Wall Street’s mind. Inflation isn’t going down, so raising prices just keeps gross profit flat for most companies. And Stifel finds in its recent survey data greater consumer concern about grocery prices. “This could lead to higher levels of elasticity for branded food products. With private label products on average around 35-40% below the price of branded foods, we could start to see commercial activity down,” Growe said.

Wall Street and the C-suite fear the breaking point for grocery prices is near.

Stifel

That hasn’t happened yet, but CFOs at major companies tell CNBC it’s a factor to watch through the second half of 2022.

“That could start to happen in the coming months and higher elasticity could slow the profit at all prices,” Growe said.

Elasticity, a measure of the relationship between price changes and consumer demand, broke with history this year. But it’s safe to say that the consumer is nervous.

The University of Michigan consumer survey last Friday found that Americans’ expectations that their personal finances will deteriorate in the coming year have increased the most since the start of the survey in the mid-1940s. Half of households expect their inflation-adjusted income to fall in the coming year. Inflation has been a big part of the story, with more consumers mentioning lower living standards due to rising inflation than at any other time except during the two worst recessions in 50 years: from March 1979 to April 1981 and from May to October 2008.

Still, University of Michigan survey director Ricard Curtin says consumer confidence remains strong, with rising wage and job opportunity confidence likely to support moderate spending growth for the foreseeable future. . Moreover, the stimulus packages that led to high savings continue to bolster the purchasing power of high-income households, even as low-income consumers have less firepower.

The latest monthly reading of the Conference Board’s Confidence Index on Tuesday showed this gap between the present and the future, with current confidence slightly higher in March and up for the first time this year, a sign that the he economy remains strong, but expectations are falling again, with consumers citing rising prices, including gasoline prices.

Gallup’s latest survey of Americans out Tuesday morning found about one in five Americans (17%) saying the high cost of living, or inflation, was the nation’s most important issue.

The importance of the high-income spender to the economy

The high-income consumer is critical, notes Mark Zandi, chief economist at Moody’s, with one-third of high-income consumers accounting for 75% of all spending in the US economy. “If high-income consumers are buying, we won’t see a big impact on gross consumer business,” Zandi said.

For low-income households—by some estimates, over 60% of US households live paycheck to paycheck – high gas prices have yet to hit because they entered this cost of living shift with excessive savings and got big pay raises on top of that. “They’re living paycheck to paycheck but haven’t had to cut spending yet, but it’s coming,” Zandi said. Between rising gas prices and excess savings starting to pay off, Moody’s expects lower-income consumers to start being more cautious this spring.

A third of all consumers in the Michigan survey spontaneously mentioned that inflation had already reduced their standard of living, and gasoline prices and food prices are the two most frequent consumer purchases. As those prices go up, the pain will increase, Curtin said. But so far, “consumers are saying ‘if I don’t buy now, it won’t cost more until later.’ So you have advance purchases and it’s a self-generating cycle,” he said. -he adds. While the Russian-Ukrainian war is a generic inflationary factor for food and energy, he said the data suggests there’s a good chance companies could pass on costs to the rest of the world. year and that consumers are receptive.

Consumer sentiment readings are also not a perfect telltale, given pandemic-era angst, now combined with inflation and a war in Europe. But even though sentiment is influenced by these factors — as well as politics, which Curtin says has risen as a partisan divide in the data — recent data shows that consumer sentiment is fragile.

“Look at discretionary items and spending on meat, steak, start to go down, or you start to see less dining in restaurants that cater to low- and middle-income households, restaurant chains,” Zandi said. “When they trade various consumer items, that’s the real deal.”

Zandi is also watching for cracks in the housing market that are already becoming evident in pending home sales and existing home sales. “We expect housing price growth to hit the wall very soon, and we might even see some weakening in prices, not next month, but definitely around this time next year,” Zandi said.

Housing market prices have been elevated, which is critical because not only is housing the most rate-sensitive sector of the economy and already showing signs of strain as mortgage rates rise, but the inevitable damage are key to how the US consumer thinks about their overall finances. When people buy and sell homes, they also make a lot of other purchases, from cars to furniture to home renovations, and that generates a lot of additional consumer activity. “The ripple effects will be big, and the other link is house prices and people who feel like they have equity, feel better about borrowing against cards,” Zandi said. “It just feels like it can’t go on. It’s tenuous.”

The Michigan Consumer Expectations Survey has a long track record of predicting recessions throughout the post-World War II era. It falls before an economic downturn, on average six months to a year in advance, and it’s falling now. “We’re going through a tough time,” Curtin said.

The University of Michigan Consumer Expectations Index predicted recessions, which are indicated by gray bars in this chart.

University of Michigan Consumer Surveys

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