Consumers are finally tapping out … how Luke Lango interprets this as bullish for stocks … a recession indicator just triggered – but it’s bullish? … keep your eye on the Sahm Rule

Consumers are tapped out…

But that could be bullish for stocks.

A recurring theme we’re seeing during this earnings season is that the “resilient” U.S. consumer is finally showing less resilience.

Let’s go to CNBC’s recent article titled “McDonald’s and other big brands warn that low-income consumers are starting to crack”:

Some of America’s best-known corporations are saying their consumers are being pinched by inflation as prices continue rising…

“It is clear that broad-based consumer pressures persist around the world,” McDonald’s CEO Chris Kempczinski said on the fast-food chain’s earnings call early Tuesday.

“Consumers continue to be even more discriminating with every dollar that they spend as they faced elevated prices in their day-to-day spending.”

We’ve heard the same takeaway from other consumer discretionary companies this earnings season including Starbucks, Amazon, 3M, and Newell Brands (the owner of Rubbermaid and Coleman bands). The slowdown in spending comes as consumers are growing more pessimistic about their financial health.

From AP News:

U.S. consumer confidence deteriorated for the third straight month as Americans continue to fret about their short-term financial futures with prices and interest rates still elevated…

The index measuring Americans’ short-term expectations for income, business and the job market tumbled to 66.4 from 74 last month. That’s the lowest reading since July of 2022. A reading under 80 can signal a potential recession in the near future.

As we’ve stressed repeatedly here in the Digest, U.S. consumers are the backbone of our economy, making up almost 70% of GDP.  Their health will ultimately make or break this bull market because stocks eventually mirror the condition of earnings… and earnings eventually mirror the health of the U.S. consumer.

So, how in the world could a weakening U.S. consumer be good for stocks?

The connection between slower consumer spending, disinflation, rate cuts, and your portfolio

To help us follow the breadcrumbs, let’s turn to our hypergrowth expert Luke Lango, editor of Innovation Investor. Here’s his big-picture synopsis:

With their savings depleted, consumers have had enough.

As a result, companies will slash prices on goods and services going into summer. We think the net result will be a collapse in the overall inflation rate to 2%. And that, in turn, will spark an enormous stock market rally.

Let’s back up and fill in a few details.

Luke explains how the biggest unknown for stocks today is inflation’s direction. Given the resurgence recently, Wall Street is having trouble positioning itself for the future.

This leaves the market in a highly reactive state that increases the possibility of a major move – though that direction is unclear. As Luke points out “if inflation does flare back up, stocks will likely crash in the summer of 2024. And if it cools down to 2%, stocks could soar.”

So, what will make or break inflation?

Well, in part, the U.S. consumer and his/her new reluctance to continue spending robustly, which is inherently disinflationary.

Back to Luke:

We believe the biggest reason inflation is going to crash this summer is shockingly simple: The U.S. consumer is done paying up for stuff.

Ever since COVID’s emergence, U.S. consumers have continued to absorb price hike after price hike on their favorite goods and services. And they’ve done so because they had money to absorb those price hikes…

But now that money’s all gone. According to estimates from the San Francisco Fed, Americans depleted the last of their pandemic-era savings in March.

With those excess savings all dried up, Americans are done splurging. They’re now value-seeking. 

This is exactly what pretty much every major consumer company has said over the past two weeks.

Connecting the dots, Luke predicts we’ll see companies forced to slash prices going into summer. The net result will be the final collapse in inflation, bringing the rate closer to the Fed’s 2% target. This win on inflation will spark a massive rally as the case for interest rate cuts from the Federal Reserve grows stronger.

As a quick side note, Luke’s favorite way to play this upcoming rally is through a specific corner of today’s AI boom – robotics. We’ll explore this in detail in a future Digest, but to check out Luke’s latest research video on the opportunity, click here.

Meanwhile, the beleaguered U.S. consumer isn’t the only “bad news is good news” influence on today’s stock market

The research shop Piper Sandler has a recession indicator that triggered after the latest employment data from the Labor Department two Fridays ago.

Here’s MarketWatch explaining this “10% recession rule”:

[The indicator triggers] when the three-month moving average of the number of unemployed people in the U.S. workforce rises 10% compared with its level from one year ago. In the past, it has been a reliable indicator that a recession is coming.

Below is a chart showing data back to 1950, highlighting when this rule triggered, along with recessions (shaded in red).

As you can see, with a reading of 10.5%, the rule just triggered which suggests “a recession is coming.”

Here again, how is this seemingly bad news good for stocks?

From MarketWatch:

[Michael Kantrowitz, chief market strategist at Piper Sandler] said that the rule’s triggering is more likely a harbinger of what investors would likely interpret as a welcome slowdown for the U.S. economy, rather than a recession.

He characterized it as the latest indication that the U.S. labor market is shifting back toward its pre-pandemic norm. This is likely bullish for both stocks and bonds, as it would encourage the Federal Reserve to cut interest rates, Kantrowitz noted.

This echoes Luke’s analysis: some cooling of the economy and the labor market will strengthen the case for a rate cut from the Fed – which is bullish for your portfolio.

Of course, all this depends on the critical caveat that our economy won’t cool too much. And on that note, keep your eye on this other labor market indicator that’s creeping higher.

What does the Sahm Rule tell us about the economy and a recession?

Former Federal Reserve economist Claudia Sahm gets credit for a recession indicator related to the unemployment rate.

It compares the latest three-month average of the unemployment rate with the lowest three-month average over the past year.

When the latest three-month average is 0.5 percentage points higher than the lowest three-month average, the Sahm Rule triggers, suggesting the beginning of a new recession.

Today, in the wake of April’s unemployment rate which inched up to 3.9%, the Sahm Rule comes in at 0.37%.

We’re still below the 0.50% line in the sand, but as you can see in the Sahm Rule’s three-year chart below, the trend is clearly climbing toward that recession-triggering 0.50% value.

For wider perspective, below we look at data from the Federal Reserve showing the Sahm Rule dating back to 1960.

The gray bars show recessions. Note how the Sam Rule line (in blue) begins spiking right at the beginning of each recession.

We’ll keep our eye on this and will update you if/when it triggers.

In the meantime, if Luke is right, the fatigued U.S. consumer is actually a good thing for your portfolio thanks to its disinflationary impact.

We’ll get the latest data on all this tomorrow morning when we get the April Producer Price Index report. Then on Wednesday, the Labor Department releases April’s Consumer Price Index data. If these reports come in cool, look for a major relief celebration on Wall Street.

We’ll keep you updated here in the Digest.

Have a good evening,

Jeff Remsburg