Where the market sees signs of a consumer inflation breaking point

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

At some point, consumers will begin to deter higher prices due to demand shocks, supply chain disruptions and rising energy prices. But they haven’t yet. So far, companies 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 savings rate among Americans not yet fully tapped are all contributing to the current economic strength.

The latest data from early earnings reports is encouraging. Last week, General Mills’ quarterly results showed no signs of consumers looking for “cash redemption” on supermarket shelves.

“If General Mills is any indication, all is well,” said Stifel analyst Chris Growe. “I don’t want to exaggerate, but their performance last quarter was strong, relative to expectations, and their guidance was even better.”

Double-digit price increases in the most recent quarter, along with cost savings, will more than offset inflation for the company, according to Stifel’s analysis.

“There are so many prices coming through (nearly 11% in the month of February for our large-cap food businesses) that it will actually be enough to offset inflation,” Growe said. “There is increasing confidence in the relatively short term around this price/cost balance that is holding up.”

But how long this situation lasts as a good one for both profits and the wallet is on Wall Street’s mind. Inflation is not declining, so raising prices keeps gross profit dollars the same for most companies. And Stifel finds more consumer concern about food prices in his recent research data. “That could lead to greater elasticity in the branded food products. With private label products averaging 35%-40% below the price of branded food, we could start to see some trade-in activity,” Growe saidWall Street and the C-suite are concerned that the consumer breaking point in supermarket prices is near.

Stifel

It hasn’t happened yet, but major corporate CFOs tell CNBC it’s a factor to monitor in the second half of 2022.

“It could happen in the coming months and higher elasticity could slow that all-price advantage,” Growe said.

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

The University of Michigan consumer survey for March last Friday found that expectations among Americans that their personal finances would deteriorate over the next year, increasing for the most part since the study’s inception in the mid-1940s. Half of all households expect a fall in inflation-adjusted income next year. Inflation was a big part of the story, with more consumers reporting declining living standards as a result of rising inflation than ever before, except during the two worst recessions of the past 50 years: from March 1979 to April 1981 and from May to October. 2008.

Nevertheless, Ricard Curtin, research director at the University of Michigan, says consumers remain strong, with confidence in rising wages and employment likely to support moderate spending growth for the foreseeable future. In addition, the stimulus packages that led to higher savings continue to bolster the purchasing power of higher-income households, even as lower-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, a sign that the economy remains strong but expectations are falling again, with consumers referring to rising prices, including gas prices.

Gallup’s latest survey of Americans on Tuesday morning found that about one in five Americans (17%) said the high cost of living, or inflation, was the number one problem facing the nation.

The importance of high-income people for the economy

High-income consumers take center stage, notes Mark Zandi, chief economist at Moody’s, with one-third of higher-income consumers accounting for 75% of all spending in the U.S. economy. “If the high-income consumers are buying, we won’t see a big impact on raw consumer activity,” Zandi said.

For low-income households—more than 60% of U.S. households live paycheck to paycheck by some estimates—high gas prices have not yet been reached because they changed this cost of living with excess savings and got steep pay increases on top of that. “They live paycheck to paycheck but haven’t had to pay back yet, but that’s coming,” Zandi said. Between higher gas prices and excess savings starting to pay off, Moody’s expects lower-income consumers to become more cautious this spring.

A third of all consumers in the Michigan survey spontaneously said that inflation has already lowered their standard of living, and gas prices and food prices are the two most common consumer purchases. As those prices rise, the pain will increase, Curtin said. But until now, “consumers say, if I don’t buy now, it will only cost more later.” So you have anticipatory purchases and that’s a self-generating cycle,” he added. While the war between Russia and Ukraine is an inflation factor for both food and energy, he said the data suggests there’s a good chance businesses will be able to pass costs on for the rest of the year and consumers will be receptive.

Consumer sentiment measurements aren’t a perfect indicator either, given fears of the pandemic era, now combined with inflation and a war in Europe. But even if sentiment is swayed by these factors — as well as politics, which Curtin said has widened as a partisan gap in the data — recent data shows consumer confidence is fragile.

“Look at the discretionary items and spending on meat, steak, or you start eating out less at restaurants that cater to lower and middle income households, the chain restaurants,” Zandi said. “If they trade in different consumer items, that’s the real story.”

Zandi also looks at the cracks in the housing market that are already showing up in ongoing home sales and existing home sales that are transitioning. “We expect house price hikes to hit the wall pretty quickly, and we may even see some weakening in prices, not next month, but definitely by this time next year,” Zandi said.

Home prices have been strong, and this is critical because not only is housing the economy’s most interest-rate sensitive sector and already showing signs of stress as mortgage rates rise, but the inevitable damage is also key to how the US consumer feels. about their overall finances. When people buy and sell houses, they also make a lot of other purchases, from cars to furniture to home improvements, and it creates a lot of extra consumer activity. “The ripple effects will be significant, and the other link is house prices and people who feel they have equity, and feel better about borrowing against cards,” Zandi said. “It just doesn’t feel like that can go on. It feels weak.”

Michigan’s research on consumer expectations has a long track record of predicting recessions during the post-World War II era. It’s ahead of an economic downturn averaging six months to a year ahead, and it’s falling now. “We’re going to have a tough time,” Curtin said.

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

University of Michigan Consumer Surveys

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