Inflation and consumer sentiment

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Does Inflation Explain Weak Consumer Sentiment?

Consumer sentiment is better now than it was in the dark days of 2022, but has been weakening since this spring and is still at the level of the Great Financial Crisis. There’s a pretty good explanation for this: consumers are still reeling from inflation. If you plot the University of Michigan Consumer Sentiment Index against CPI inflation, you see a fairly reliable inverse correlation going back 70 years. Here I’ve reversed the scale for the CPI to make the relationship easier to see:

Historical lows in consumer sentiment have also aligned with recessions. Inflation, that is, has tended to be stagflation. We can see this by comparing consumer sentiment and the unemployment rate (again, we’ve reversed unemployment here; the midpoints of official recessions are marked by dotted lines):

There is one curious thing though. This time, except for a very short and very violent recession in the spring of 2020, the link between sentiment and unemployment has been broken. Unemployment is very low and feelings are bad anyway.

What to make of it? One could argue that as inflation recedes into the background, sentiment will continue to rise as long as unemployment remains low. This would bode well for the economy and markets. But I wonder if, in the pandemic years, anything has changed in terms of how people think and feel about the economy.

The decline in packaged food revenues

Late last year, Unhedged wrote several articles about how packaged food stocks have fared remarkably poorly. We struggled to understand what was wrong:

Some of it can be explained idiosyncratically. Several of the S&P food stocks are simply underperforming. Many companies in the group only generate revenue growth due to price increases; volumes are flat. But ConAgra, Hormel and Tyson don’t even manage price increases. Kraft Heinz gets price, but only at the cost of lower volumes. Both Campbell’s and Smucker’s made big acquisitions (Rao’s pasta sauce and Hostess snacks, respectively) that investors didn’t seem to like. But these individual failings, it seems to me, don’t really account for the terrible performance of the group. . . Not everything can be due to GLP-1 diet drugs.

I knew the food companies had continued to screw up, but I wasn’t aware of how widespread the malaise had become until I read some interesting posts on Adam Josephson’s Substack, As the Consumer Turns. Josephson offers this amazing list of consumer companies that have lowered their sales or earnings targets in the last four months or so:

The many disappointments are visible in the performance of the S&P 500 Food Products sector, which had managed to keep pace with the index in 2022 when defensive stocks were in demand:

As Josephson points out, this is inconsistent with what otherwise appears to be a strong economy driven by strong consumer spending.

Part of the problem is visible in macroeconomic data. Here’s the growth in several categories of real consumer spending since the start of the pandemic:

Growth in goods consumption followed services and was negative for much of 2022. Food and beverages followed goods and just returned to positive territory.

Why? For goods in general, the issue could be a lingering echo of the pandemic shutdowns, when we all sat at home ordering Peletons and air fryers. This was all demand drawn from the future, leading to a crisis that is only now ending. But it’s hard to grow a large demand for food unless it’s canned.

One possibility is that branded food companies have ceded market power to large retailers and their house brands. Packaged food companies have less pricing power than they once had and have had to give more margin to retailers to move their products. Warren Buffett attributes the poor performance of his investment in Kraft to this phenomenon.

The poor performance of food companies hasn’t dented their stocks, at least not collectively. The sector’s forward price/earnings ratio, at 16, is historically normal. The stock’s poor performance is entirely due to weak earnings growth. Until that changes, there seems to be no reason to bet on the sector.

Was the strong US jobs report out of whack?

On Monday, I cast some doubt on the September jobs number, pointing out that 1) it is likely to be revised down given recent problems with the birth-death pattern, and 2) 254,000 is not great given view the growing size of the workforce. Others echoed our skepticism. Here are some of their points:

• Employment and withdrawal: Claudia Sahm points out that the August Jolts report showed that the employment rate fell to a historic low in line with much higher unemployment. Peter Coy adds that dropout rates are also down, at a post-pandemic low. A labor market where employees are uncomfortable leaving their jobs, either because they fear a recession or because other companies aren’t hiring, suggests underlying weakness despite job creation.

  

• Temporary workers and hours worked: Paul Ashworth of Capital Economics points out that the steady decline in temporary employment and hours worked is also consistent with weaker wage growth. This is good news on the inflation front because the economy has plenty of people ready to work more if things start to heat up. Average hours worked and the number of temporary workers appear to be returning to their pre-pandemic trends rather than falling below them. Still, as Ashworth says, the rate of change is consistent with a weakening labor market.

We highlight these arguments not necessarily because we believe them or because we think the jobs report was terrible. But we think September may have been an anomaly (even though we hope it wasn’t).

(Reiter and Armstrong)

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