Today’s Dour Consumer Moods Don’t Foretell Their Future Actions

The University of Michigan (U-Mich) released the preliminary May results for its widely watched consumer sentiment survey last Friday. Perhaps unsurprisingly, given the rampant handwringing over West Coast regional banks and the simmering debt ceiling standoff, the index fell to a six-month low. But today’s downbeat consumers don’t necessarily foreshadow things to come—as the U-Mich survey’s history illustrates. 

The U-Mich consumer sentiment index fell to 57.5 from April’s 63.5, below expectations and the weakest reading since last November. While moods have been broadly dour since February 2020 (during the first COVID lockdown and bear market), the survey responses also persistently exhibit a noticeable partisan divide—highlighting politics’ effect on people’s moods. For example, those who identified as Republican have consistently responded more negatively than those who identified as Democratic since November 2020, when Democratic candidate Joe Biden won the presidential election. (Exhibit 1) But regardless of party affiliation, U-Mich’s gauge has yet to return to pre-pandemic levels.

Exhibit 1: U-Mich Consumer Sentiment Index Since 2018

Source: FactSet and the University of Michigan’s “Survey of Consumers,” as of 5/16/2023. Consumer Sentiment Index Level, headline and by political party, monthly, January 2018 – March 2023. March 2023 is the latest available for Consumer Index Level by political party.

The survey also noted fears from prolonged recession to debt ceiling fallout weighing on respondents in May. Prices remain on people’s minds, too, as long-run (i.e., five-year) inflation expectations hit 3.2%, the highest since 2011. We aren’t surprised these topics color respondents’ outlooks. Americans have been grappling with challenging conditions for the past couple years, from elevated inflation and tragic geopolitical developments to financial sector troubles and nonstop political bickering. But from an investing perspective, it is critical to remember people’s views of the future aren’t predictive.

One way to see this: those long-run inflation expectations. Go back to March 2011, when inflation expectations were as high as today’s. Then, rising gasoline prices were U-Mich survey respondents’ biggest gripe. US retail gas prices had been climbing from December 2008’s relative low of $1.75 a gallon, but price growth began accelerating in late 2010—climbing from $2.76 a gallon in September 2010 to $3.62 a gallon in March 2011.^[i] That jump fueled (sorry) fears that gas would get back to mid-2008 highs and stay there, rendering the earlier drop a short, recession-related aberration. With March headline inflation up to 2.6% y/y, U-Mich respondents’ five-year inflation outlook ticked up from February’s 2.9% to March’s 3.2%.^[ii]

Those expectations looked prescient in the short term as inflation broke through the 3.0% threshold the next month and remained there for the rest of the year (peaking in September at 3.8%). Gas prices also hit a relative high of $3.96 a gallon in May and stayed in the $3-range for the next three years. But consumer price growth ended up slowing over the next several years—and there was even a short bout of deflation in early 2015. (Exhibit 2) Five years from March 2011, the CPI inflation rate was just 0.9% y/y. Interestingly, the March 2011 five-year breakeven inflation rate—which reflects what market participants expect inflation to be in the next five years—was 2.2%, a full percentage point lower than U-Mich survey respondents’ prediction. Though 5-year Treasury investors’ outlook was closer to reality than consumers’, it was still well wide of the mark—a reminder the distant future is unknowable and that inflation expectations aren’t predictive. They are, at best, coincident.

Exhibit 2: US CPI vs. Expectations

Source: FactSet and St. Louis Federal Reserve, as of 5/16/2023. US CPI (year-over-year change), March 2011 – March 2021, 5-year expected inflation from University of Michigan’s “Survey of Consumers” for March 2011 and 5-year breakeven inflation rate as of March 31, 2011.

Although the U-Mich survey doesn’t have many forward-looking takeaways, its findings are consistent with other sentiment gauges in America and abroad. For example, US IPO activity is at a post-pandemic low.^[iii] Surges in IPOs may signal optimism turning into euphoria as businesses go public to take advantage of hot demand. We saw those conditions in the late 1990s and early 2000 and, to a lesser extent, in early 2021 (e.g., special-purpose acquisition company debuts). Likewise, a dearth of activity can indicate low demand—perhaps signaling pessimism’s prevalence. Elsewhere, Bank of America’s global fund manager survey found sentiment worsened in early May, with 65% of those polled anticipating further economic weakness.^[iv] Overseas, Germany’s ZEW Indicator of Economic Sentiment fell back into negative territory for the first time since December 2022.^[v] No one sentiment metric is all-telling, but when taken in aggregate, today’s measures suggest a majority are feeling down about the economy.

For investors, the key question to ask is how these expectations align with economic reality. We see lots of signs the US and many other developed economies are muddling along. There are undoubtedly weak spots, but tepid growth is a far cry from recession—which policymakers in the UK and EU have recognized recently. In our view, the wall of worry bull markets climb is high, and we see more and more signs that is the situation today.