U.S. consumers are finally pulling back … the market’s feedback loop is broken … can we trust earnings estimates? … a big event tonight with Eric Fry and TradeSmith CEO, Keith Kaplan

 

The great financial reckoning has begun.

Two headlines from Monday and Tuesday sum up the condition of the U.S. consumer today…

The Wall Street Journal:

Americans Finally Start to Feel the Sting From the Fed’s Rate Hikes

Bloomberg:

Only Richest 20% of Americans Still Have Excess Pandemic Savings

For months in the Digest, we’ve urged readers to maintain perspective on the regularly repeated phrase “resilient consumer.” We’ve argued that this alleged resilience has been smoke and mirrors – an illusion created by artificial stimulus dollars and a record amount of credit card debt.

Our fear has been “what happens when those savings evaporate, credit card balances become unwieldy, and the U.S. consumer runs into the brick wall of reality?”

No one knows.

Maybe it will be disastrous… or perhaps it will be a big nothingburger.

It’s hard to forecast what’s coming because the feedback loop between the consumer and the economy has been broken for a long time

Imagine a normal economy, one without the artificial influence of stimulus dollars or a pandemic.

When consumer prices climb, and/or real wages fall, we would see a relatively real-time reaction in consumer spending.

Perhaps overall spending volumes would drop… or savings account values would decrease… perhaps credit card balances would increase…

The point is there would be a feedback loop. A cause-and-effect that would reveal the true economic health of the consumer.

The pandemic destroyed this feedback loop in two ways:

First, goosed savings from pandemic stimulus money enabled the U.S. consumer to spend at a rate that didn’t reflect real, disposable income and organic savings. So, the traditional signals of consumer health were crowded out by a tsunami of freshly-printed dollars.

As financial conditions tightened, U.S. consumers didn’t react – they just kept spending.

Here’s Bloomberg:

Real income growth has slowed to levels below the pre-pandemic trend, according to [a report from the Brookings Institution).

Meanwhile, consumers kept their spending habits from a couple of years ago, when forced inactivity and Covid government support payments bolstered their savings…

“If households were to sustain their current spending trends and increasingly finance spending with borrowing, financial health could deteriorate in a worrying way,” the analysts wrote.

And here’s Yahoo! Finance:

…The painful reality of inflation has pummeled households…

Signs of cooling consumer spending point to the next phase of the pandemic economy, where the perception of resilience is shaded by darker undertones…

“It is unlikely that these current levels of spending will prove sustainable, and we will see the consumer begin to pull back,” [said Nicole Tanenbaum, partner and chief investment strategist at Chequers Financial Management].

But exactly how much of a spending pullback? That’s what’s challenging to forecast.

The second way that the pandemic destroyed the feedback loop is by fracturing the U.S. consumer’s psyche

The fracture resulted in “revenge spending” that largely endorsed spending beyond one’s means.

A New York Times article in March explained the phenomenon:

At first, I spent little during the pandemic’s early days.

With bars and restaurants shuttered and no incentive to buy shoes or clothes, my primary indulgences had been nullified. I paid down my credit card balance and began saving in earnest for the first time in years.

My good habits dissolved in the fall of 2020. 

The author goes on to describe her “new lust for purchasing” that took on a life of its own as “revenge spending” became her norm after her vaccination.

Here’s how she described her eventual spending breakdown in her monthly budget:

In the months after I was vaccinated, my [spending] percentages were closer to 50 percent spent on my needs, 100 percent set aside for my wants and 0 percent for savings and investing.

My credit card made up the difference. 

Clearly, that was never going to be sustainable. Yet this mindset affected the purchasing decisions for millions of consumers – again, distorting the feedback loop, presenting the appearance of “consumer resilience.”

How long until these revenge-minded consumers can no longer spend because their enormous credit card balances are too unwieldy?

We showed the chart below on Monday. It’s credit card delinquencies dating back to the year 2000.

Notice that we’re coming off historic low levels (more distortion from the pandemic), yet the recent slope of delinquencies is the steepest it’s been outside of the 2008/2009 recession.

On that note, I’ve added two trend lines since this chart has a longer timeframe, making it harder for you to see the changing slope.

This blue trendline shows the slope of delinquencies since 2022. The red trendline shows how these delinquencies have accelerated from Q1 to Q2 (the latest data we have).

Imagine how much steeper the slope will be once when we get Q3 data.

Bottom line: The temporary ability to spend beyond means (thanks to pandemic stimulus) and the psychological desire to spend “for the moment” without a concern for the future (thanks to pandemic psychology) distorted the market/consumer feedback loop.

The traditional distress signals were lost or ignored. But as Ayn Rand wrote, “You can ignore reality, but you cannot avoid the consequences of ignoring reality.”

We’re about to have a reckoning with reality, but no one knows exactly what that means.

If we’re on the verge of a consumer pullback in spending, what will power corporate earnings – and by extension, the stock market?

Yesterday’s Digest featured bullish analysis from Luke Lango based on the combination of earnings estimates and historical price-to-earnings ratios (PE).

If earnings estimates are accurate and S&P’s forward earnings multiple comes in at the top of its historic range, then Luke says we’re in for 33% gains over the next 15 months.

That would be fantastic, and we hope it happens.

Clearly, the primary driver of that hypothetical is earnings and whether estimates will prove accurate as the U.S. consumer faces this reckoning with reality. Remember, U.S. spending accounts for nearly 70% of the U.S. economy. So, if it slows, so too will corporate earnings.

As we mull this, it’s important to remember that analysts often see the world with rose-tinted glasses. Here’s FactSet from a study a few years ago, noting how analysts usually get it wrong by overestimating future earnings:

Over the past 25 years (1997 – 2021), the average difference between the bottom-up EPS estimate at the beginning of the year (December 31) and the final EPS number for that same year has been 7.0%.

In other words, industry analysts on average have overestimated the final EPS number by 7.0% one year in advance.

Analysts overestimated the final value (the final value finished below the estimate) in 17 of the 25 years…

Hopefully, we’re headed into one of the years in which the analysts get it right – but we must consider the opposite.

So, let’s pull back and connect the dots so far…

We have a big question mark concerning the strength of the U.S. consumer thanks to a broken feedback loop… leading to a big question mark for the strength of upcoming corporate earnings… leading to a big question mark for the stock market and your portfolio.

Meanwhile, for added perspective, we have a stock market that has returned 0% in the last 27 months.

So, if the consumer and corporate earnings are at risk of disappointing us going forward, how do you prevent 0% returns over the coming 27 months?

Tonight at 8 PM Eastern, our macro expert Eric Fry is sitting down with TradeSmith’s CEO Keith Kaplan to discuss a powerful workaround to this risk

Tonight’s event highlights a smarter way to invest that’s rooted on something called a VQ (Volatility Quotient), which measures the inherent movement in a stock. Keith calls this “the single most important number in investing.”

Here’s how Keith had been investing prior to his awareness of the VQ:

…Until I had these tools that I had it all wrong. I was buying just a little bit of the low-risk stocks and a lot of the high-risk stocks and then overtrading because I couldn’t sleep at night!

But with a greater understanding of a stock’s VQ, Keith saw investing in a completely different light. He was able to discern “exactly when to buy, how much to buy, and when to sell any stock, fund, or crypto. It’s really powerful.”

The idea of zeroing in on a specific stock’s unique volatility echoes a point we make frequently in the Digest:

It’s not so much a stock market as it is a market of stocks. In other words, the S&P is made up of thousands of different companies with wildly different economic fates.

Some companies will have explosive earnings next year; others will barely survive. Some stock prices will be wildly volatile and explode higher while others will barely budge.

A VQ reflects this “each stock is different” reality.

Armed with this VQ awareness, investors can better understand the unique volatility fingerprint of any given stock. And from that, they can create an investment plan that blends any given stock into a broader portfolio to maximize risk-adjusted returns.

On this “portfolio” note, here’s Keith taking about his “Pure Quant Portfolio Builder,” something he’ll discuss in more detail tonight:

You literally just tell it a source of stocks, a dollar amount, and how many stocks you want to buy…

It gives you a portfolio of healthy stocks that is diversified, risk-adjusted, and reads like a recipe for investing that you can execute in your own brokerage account.

Tonight at 8 PM, Keith and Eric will fill in all the details, demo this powerful trading tool, and show you how it can both simplify and improve your investing.

Yes, we’re facing uncertainty with the U.S. consumer… and yes, it’s unclear how corporate earnings and the S&P will perform going forward…

But your investments aren’t doomed to underperformance. Join Eric and Keith tonight to learn more about how this VQ works, the Pure Quant Portfolio Builder, and why Eric even called it “the Holy Grail of investing.”

Click here to reserve your seat and we’ll see you tonight at 8 PM Eastern.

Have a good evening,

Jeff Remsburg