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A big question both on Wall Street and corporate C-suites is consumer strength, how long can it last?
At some point consumers will start to shy away from higher prices caused by demand shocks, supply chain disruptions and rising energy prices. But they haven’t yet. So far, companies have been able to pass on the higher costs and consumers have been willing to pay for them. Higher wages, job confidence, and Americans’ historically high savings rates that have not yet been fully exploited 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 sign of consumers wanting to “trade down” on the supermarket shelf.
“If General Mills is any indication, all is well,” said Stifel analyst Chris Growe. “I don’t want to exaggerate but their performance this past quarter has been strong compared to expectations and their guidance was even better.”
According to Stifel’s analysis, double-digit price increases in the most recent quarter, combined with cost savings, will more than offset inflation for the company.
“There’s so much price coming through (almost 11% up in February for our large-cap food companies) that it will actually be enough to offset inflation,” Growe said. “There is an increasing level of confidence in the relatively short-term implementation of this price/cost balance.”
But how long this situation, which is good for both bottom line and wallets, lasts is of concern to Wall Street. Inflation isn’t abating, so for most companies a price hike just means gross profit in dollars is flat. And Stifel finds more consumer concerns about food prices in its latest survey data. “That could lead to greater elasticity in branded groceries. With private label products priced on average about 35% to 40% below the price of branded groceries, we may start to see trade declines,” Growe said.
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Wall Street and the C-Suite are concerned that the consumer tipping point in grocery store pricing is near.
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It hasn’t happened yet, but big company CFOs tell CNBC it’s a factor to monitor into the second half of 2022.
“It could start in the coming months, and higher elasticity could slow down that benefit from all the prices,” 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 nervous.
The University of Michigan consumer survey last Friday for March found that Americans’ expectations that their personal finances would deteriorate in the coming year rose by the largest percentage since the survey began in the mid-1940s. Half of all households expect falling inflation-adjusted incomes in the coming year. Inflation was an important part of the story, with more consumers mentioning falling living standards due to rising inflation than at any other time except during the two worst recessions of the past 50 years: March 1979-April 1981 and May-October 2008.
Nonetheless, University of Michigan tuition director Ricard Curtin says consumers remain strong and have confidence in rising wages and job opportunities — over 4 million Americans quit their jobs in February — that will sustain moderate spending growth for the foreseeable future. In addition, the stimulus packages that led to increased savings continue to bolster the purchasing power of higher-income households, even as lower-income consumers have less firepower.
The Conference Board’s latest monthly confidence index reading on Tuesday showed that gap between present and future, with current confidence slightly higher in March and rising for the first time this year, a sign the economy remains strong but expectations below on consumers again falling rising prices, including gas prices.
Gallup’s latest poll of Americans, released Tuesday morning, found about one in five Americans (17%) said the high cost of living, or inflation, was the nation’s biggest problem.
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The high-income consumer is key, notes Mark Zandi, chief economist at Moody’s, with a third of high-income consumers accounting for 75% of all spending in the US economy. “If the high-income consumers are on the go, we won’t see a big impact on raw consumption activity,” Zandi said.
For low-income households — by some estimates, over 60% of U.S. households live paycheck-to-paycheck — high gas prices have yet to take hold because they entered this cost-of-living shift with excessive savings and received strong pay increases on top. “They’re living paycheck to paycheck and haven’t had to cut back on spending yet, but that’s coming,” Zandi said. With higher gas prices and the start of excess savings, Moody’s expects lower-income consumers to be more cautious this spring.
One-third of all consumers in the Michigan survey spontaneously mention that inflation has already reduced their standard of living, and Gas prices and food prices are the two most common purchases made by consumers. As those prices go up, the pain will increase, Curtin said. But so far, “consumers are saying if I don’t buy now, it’ll just cost more later.” So you have anticipatory buying and it’s a self-generating cycle,” he added. While the Russia-Ukraine war is a wildcard inflationary for both food and energy, the data suggested companies have a good chance of absorbing the costs for the remainder of the year and consumers will be receptive.
Consumer sentiment readings are also less than perfect given fears of the pandemic now being combined with inflation and a war in Europe. But even as sentiment is affected by those factors — as well as politics, which Curtin says has risen as a partisan divide in the data — recent data shows consumer sentiment is fragile.
“Look at the discretionary items and spending on meat, steak, starts to go down, or you see fewer restaurants in restaurants that serve low- and middle-income households, the chain restaurants,” Zandi said. “If they deal in different consumer goods, that’s the real lead.”
Zandi is also watching the cracks in the housing market, which are already showing in pending home sales and existing home sales. “We would expect house price growth to hit the wall fairly soon and we might even see some moderation in prices, not next month but certainly by this time next year,” Zandi said.
Housing market prices have been strong and this is crucial given that not only is housing the most interest rate sensitive sector of the economy and is already showing signs of stress from rising mortgage rates, but the inevitable damage is a key factor in how US consumers are feeling about theirs entire finances. When people buy and sell homes, they also make many other purchases, from cars to furniture to home improvement, and this leads to a lot of additional consumer activity. “The ripple effects will be significant, and the other connection is house prices and people who feel like they have equity and feel better about borrowing against cards,” Zandi said. “It just doesn’t feel like it can go on like this. It feels weak.”
Michigan’s Consumer Expectations Survey has a long track record of predicting post-WWII recessions. 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 difficult time,” Curtin said.
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The University of Michigan Consumer Expectations Index forecasts recessions, denoted by gray bars on this chart.
University of Michigan Consumer Surveys