Personally, I try not to get too hung up on consumer confidence surveys. They are helpful, but as always it’s what folks do as opposed to what they say that’s ultimately important to real economic and financial market outcomes. Moreover, one month’s data certainly does not make a trend. But the University of Michigan consumer confidence survey released last week is at least deserving of contemplation in terms of a near term message. In the chart below I’m covering UofM data across the entire official economic recovery period to date (the recession having ended according to the NBER in June of 2009).
The University of Michigan consumer confidence survey numbers regarding consumer expectations for forward 1 year inflation bottomed literally after the Fed’s Jackson Hole conclave late in the summer of last year as Bernanke made it clear yet another round of money printing (quantitative easing) was on the way. And these expectations for increased inflationary pressures have been rising ever since, with a very big spike up seen in the March numbers recently reported.
Accompanying this spike in inflation expectations was a more than noticeable drop in the future expectations component of the headline confidence number itself to the lowest reading in the recovery to date. The magnitude of the current month over month drop has only occurred six times in the 33 year history of the numbers - a 1.5% statistical occurrence. The recent data in the survey force me to at least start asking the question, have consumers hit a tipping point in terms of the interplay of confidence relative to the reality of real world acceleration in day to day cost of living?
Before moving ahead, a quick look at the UofM inflation expectations over the entire history of the data. Important why? Because we now rest at a level that has essentially been rarified air over the last three decades. In fact the only time the current inflation expectations response level has exceeded the current reading was when crude oil was pushing near 0 per barrel in mid 2008.
Again, one month’s data does not make a trend. And it’s clear US households have been hit with a fair number of psychological negatives over the recent past. From the tragedy in Japan to social unrest in the Middle East, to per gallon staring them in the face at the gas pump, it’s been a lot to deal with. So in one sense the anomalistic drop in confidence is understandable. But the rise in inflationary expectations must be watched as we move ahead.
The macro inflation versus deflation debate has been raging for years now, highlighted by the Fed’s unprecedented quantitative easing campaigns of the last few years. I’ve long maintained personally that inflationary and deflationary pressures will co-exist due largely to the 800 pound gorilla of secular change that has been and continues to be globalization. As an example, it is clear that over the recent period of quantitative easing, the US Fed has essentially been exporting inflation to the remainder of the world. The very meaningful rise in global food prices were the initial spark that lit the fuse in Middle East turmoil and social unrest, as well as being the reason for emerging market economy monetary tightening (raising interest rates). In like manner, a country like China has been academically importing unemployment to the US and other developed economies for years now, of course very much apparent in unprecedented US labor market weakness amidst the current economic recovery. From a macro standpoint, we can consider a very historically high unemployment rate as being deflationary. Is this tension between inflation and deflation simply all part of the evolutionary pains of an ever interdependent and interconnected world? Conceptually, this is exactly what I believe is playing out right before our eyes.
Back to US consumers and their currently rising perceptions of inflation. Without heading off into tangential commentary, the history of inflation in the US economy specifically has been very consistent. The KEY in each inflationary spike has been that wage inflation occurred in response to a rising cost of living. Completely consistent in US post war experience. We all remember oil prices rising in what was considered to be shocking fashion in the 1970’s. But do you also remember that between 1975 and 1980 US wage growth was rising between 6 and 9% annually? In essence wage growth blunted a rising real world cost of living for consumers. Consumers may have been no better off in real (inflation adjusted) terms, but rising wages helped keep rising oil prices at the time from crowding out other forms of household consumption.
Fast forward to the present and the world has changed for US consumers, especially over the last half decade. Heightening in my mind why current consumer perceptions of rising prices is so important a monitor point. Let's start with a quick graphic view of life. There is an historical linkage of importance that at least demands a bit of recognition and attention. Below you are looking at the very simple longer term picture of nominal dollar West Texas crude prices. Alongside is the year over year change in US service sector wages (please remember that the service sector accounts for 83% of private employment stateside as of the latest numbers). I've drawn in the green bars to help identify historical periods where oil prices have risen in pretty meaningful fashion. From the initial "oil crisis" period of the early 1970's through to the middle of the prior decade, there appears to be a bit of consistency between rising oil prices and a rising year over year rate of change in US service sector wages. This tells us that at least in part a rising rate of change in broad US labor market wages has helped offset the impact to a point of rising crude prices in the past.
But what is also clear is that with the spike in oil prices over the 2007-2008 period, there was no corresponding lift in the rate of change in US wages. In fact, quite the opposite. With no corresponding lift in wage growth, the spike in oil prices was a direct tax on US households that necessarily meant an offset to other forms of household consumption in deference to funding that implicit oil price spike "tax". And what do we see happening now in terms of this important relationship? Once again the dichotomy between the trajectory of crude prices and broad US wage growth so apparent from 2007-2008 is even more pronounced in the current cycle. US service sector annual wage growth is nearer three decade lows than not while nominal dollar crude prices are again reaching for blue skies. Of course this set of circumstances in the prior cycle was in good part a prelude to recession. In the spirit of honesty and integrity, the collapse of the credit markets accompanied the prior downturn, so there is a meaningful cycle differential at work for now, but this does not mean crude prices are of little consequence in the here and now.
Although the Fed likes to look at “core” inflationary measures (excluding food and energy) when assessing the magnitude of inflationary pressures in the US economy at any point in time, US consumers are not so lucky. So, let’s put ourselves into the current shoes of the real world US consumer one more time and have a look at the dynamics of food costs and consumer financial circumstances historically. It just so happens that a body within the United Nations has compiled a global world food price index that stretches back a few decades.
Right to the point, once again we see very similar rhythm. I've marked with green bars the historic instances where the UN's measure of food prices accelerated in a meaningful manner. Once again, every occurrence of rising food prices over the past few decades was accompanied by rate of change acceleration in domestic US wages. The sole exception is the current cycle. As with oil, just what does this suggest about a domestic consumer "margin squeeze"? What it says is that this is a very real possibility. Without domestic wage growth, higher food and energy prices are set to "displace" some alternative form of domestic consumption. My guess would be discretionary consumption – think restaurants, entertainment, etc. We simply need to watch for the expression of that displacement to come in equity sector relative price movement. A relative performance decline in the discretionary equities sector compared to both the consumer staples sector and the broad equity market as a whole has in the past been a macro warning for the financial markets and real economy of significance. We're not there yet in the current cycle, but we may be close. As always, hoping to correctly anticipate and have a game plan for all potential forward outcomes is what it's all about.
The abrupt change in consumer attitudes in the March University of Michigan consumer confidence report is either a one off event in response to the plethora of global negatives as of late, or it’s the initial and important signal of change at the margin in consumer decision making that can often be the most powerful piece of information for investors and those making real world business decisions. As we head into 1Q quarter end, I’ll suggest to you that THE most important number in upcoming corporate earnings releases will be profit margins. This is the number (as well as forward margin guidance) that will move stock prices. Are consumers likewise focused and concerned about their own “margin compression” issues, if you will? It’s sure starting to look that way. Stay tuned.
