Cooling inflation doesn’t necessarily mean cooling prices … the myriad headwinds facing the U.S. consumer … where to shift your focus today

In yesterday’s Digest, we wrote that it’s time to look beyond CPI data and evaluate the health of the consumer through additional methods.

From that Digest:

We’re entering a period in which the starting values for our inflation calculations will be so high that headline inflation numbers should drop.

But that’s not going to tell us a thing about real prices impacting your wallet.

Inflation rates can be low at the same time that prices are sky high.

For example, let’s say your next trip to the gas station costs $75 when it used to cost only $45. Next month, it also $75, which would mean month-over-month inflation is 0%.

Does 0% inflation help you at all?

No, you’re still paying $75 at the pump. That’s $30 more than your old $45 price tag, so it’s $30 you can’t spend elsewhere.

Cooling inflation does not mean relief at the cash register.

It just means the pain at the cash register isn’t intensifying as quickly.

Given this, as we analyze the consumer and the economy today, let’s pay less attention to inflation rates and more attention to absolute numbers, or perhaps different relative comparisons.

To begin this analysis, let’s actually start with the U.S. consumer’s income and nest egg. After all, his/her ability to pay higher costs is greatly impacted by the purchasing power of their income and savings account.

***Part of the challenge for the U.S. consumer is that – while wages are rising (which fuels inflation) – wages aren’t rising enough to preserve wage-based buying power

Let’s break this down.

Below, we look at data from the Federal Reserve Bank of Atlanta showing nominal wage growth since the late 1990s.

To make sure we’re all on the same page, “nominal” means the stated value. It is not adjusted for inflation over time.

I’ve circled the recent explosion in nominal wage growth beginning last year.

Behind this nominal wage growth is an imbalance in job openings and available workers.

In the wake of the pandemic and the “Great Resignation,” as it’s being called, millions of available jobs are going unfilled.

This is forcing employers to sweeten the deal, increasing salaries to lure would-be employees into those open positions.

Here’s CNBC with more:

[There is] a gap of 5.46 million between openings and the available workers, still high by historical standards and reflective of a very tight labor market, but below the nearly 5.6 million difference from March…

The shortage of workers has pushed wages sharply higher and fed inflation pressures running at their highest levels since the early 1980s.

With more dollars in their pockets from employers, workers are able to pay higher prices at the pump, grocery store, restaurant, mall, and so on…which continues to put upward pressure on prices (even if inflation rates ease).

But given that these consumer prices are increasing at a faster clip than the wage growth, here’s what’s actually happening to the buying power of these higher wages.

Below, I’ve circled the drop in median real weekly real earnings (adjusted for inflation) since 2020.

The chart above doesn’t extend through today. But here’s the latest data from the U.S. Bureau of Labor Statistics:

Real average hourly earnings decreased 2.6 percent, seasonally adjusted, from April 2021 to April 2022.

The change in real average hourly earnings combined with a decrease of 0.9 percent in the average workweek resulted in a 3.4-percent decrease in real average weekly earnings over this period.

On the “savings” front, the U.S. consumer remains in decent shape thanks to an influx of stimulus money from the federal government. But there’s an end to everything.

Yesterday, JPMorgan’s CEO Jamie Dimon said consumers have less than a year’s worth of spending power remaining.

From The Wall Street Journal:

JPMorgan Chase & Co. Chief Executive Jamie Dimon said U.S. consumers still have some six to nine months of spending power left in their bank accounts but warned of an economic “hurricane” brewing…

The head of the nation’s biggest bank said the recent drop in Americans’ savings rate hadn’t altered his view that the government’s pandemic stimulus is still padding consumers’ wallets. He estimated that some $2 trillion in extra funds are still waiting to be spent.

Mr. Dimon has been warning that the economy faces uncertainty, in part because unprecedented stimulus continues to play a role.

This is a key point to consider.

Sure, consumers are still buying today – but with what?

Well, for many, with “freebie” dollars from the federal government that won’t be replenished when spent – as opposed to recurring, disposable income from a paycheck.

So, when these fed dollars are gone, what will we find about the true condition of the average U.S. consumer?

Will the emperor have no clothes?

***Moving on to the cost side, where are prices coming in for the three biggest line items on the U.S. consumer’s budget?

Those line items are shelter, gasoline, and food.

Yesterday, we learned that home prices rose by more than 20% year-over-year in March. That’s the biggest surge in 35 years.

But as we try to move away from percentages and drive home the real impact of these prices – again, even if inflation cools off – let’s look at this differently.

Let’s compare “median household income” to the “median price of a new home.” That’s a reasonable yardstick.

Below, analyst Charlie Bilello offers us the takeaway of this comparison. He tweets:

The median price of a new home in the US is now 6.7x higher than the median household income.

Housing has never been more unaffordable relative to incomes.

Below is the chart Bilello provides, showing the data all the way back to 1967.

Now, you might be saying, “Too bad for them, but I’m a renter, so I’m fine.”

Perhaps you are, but the average renter isn’t.

From yesterday in MarketWatch:

Renters diving into a white-hot housing market are over-bidding on available apartments, marking the death knell of pandemic-era deals and months of free rent — all while potentially imperiling tenants who can’t afford to compete…

“Renters are being left with few options but to meet higher rents and, in some cases, even offer above asking — whether they can afford to or not,” Realtor.com Chief Economist Danielle Hale said in a statement this month after the real estate website released data showing the median rent in the nation’s 50 largest metropolitan areas had reached $1,827 in April. 

I’ll add that rents are up 17% year-over-year as of March.

***As to gas and food prices, they’re also sky high – and appear poised to stay elevated, even if inflation rates cool

Below, we look at U.S. retail gas prices. They’re at all-time highs.

For added context, there are some spots (most of which are in California, where I live) where a gallon of regular fuel now costs as much as the federal minimum wage of $7.25.

Worse, experts suggest we prepare for even higher prices this summer (especially now that China is easing lockdown restrictions, which means added demand). Patrick De Haan, an oil and gas analyst, puts the odds of an average price of $5 per gallon by this summer at 65%.

As for food, same story.

Below, we look at the Food Price Index dating back to 1960.

It’s never been higher.

Today’s value is 33% higher than this time last year.

So, looking big picture, the price of everything is up. Painfully, historically up.

Should it not then be cause for celebration if, in the coming weeks, we learn that inflation is finally coming down?

***Only to a degree, because the more critical detail is how retail prices – not inflation rates – are impacting the behavior of the average American shopper

To beat the thematic dead horse of this Digest, cooling inflation won’t mean that prices are dropping. It will only mean that prices aren’t rising as fast.

So, even if we’ve made it beyond peak inflation, as long as inflation is headed higher, the cost of a gallon of gas, or a burger, or your rent, is still going up.

The big unknown today – even if inflation cools – is: How long can the U.S. consumer continue to prop up the bottom lines of businesses in a high-price economic environment?

For us as investors, this is critical, because if (or when) the pain eventually shows up in corporate bottom lines, that’s when we see the effect in our portfolios.

Today, stocks have taken it on the chin as investors have adjusted price multiples based on this new inflationary world. But you could argue that the pullback we’ve seen reflects only current inflation and the increase in rates so far (as well as the best guess of how high rates will go).

But if prices remain at nosebleed levels – even if inflation goes to zero – it will eventually hit corporate earnings. And that dynamic is not currently reflected in stock prices.

Today offers us an example with Microsoft.

The tech giant just came out and cut its earnings and revenue guidance for the fiscal fourth quarter.

Though it’s blaming the strong dollar, the result is the same as it would be if the lower earnings forecast was due to weaker U.S. consumer: Microsoft’s stock price is now too high relative to its new, decreased earnings forecast.

So, this morning, investors sold it down 2% to better reflects this hit to earnings (before today’s parade of bulls pushed it back up).

Bottom line, if the coming weeks bring news of easing inflation, wonderful. That’s a start.

But it’s time to look beyond that. The issue today isn’t inflation, it’s how long the U.S. consumer can remain healthy in this high-priced economy.

Have a good evening,

Jeff Remsburg