How are you feeling? Are you feeling like things are getting better? Because a lot of other people think that way.
The July 14, 2023 Index of Consumer Sentiment from the University of Michigan (MCSI) rocketed to 72.6 from 64.4.
The MCSI measures the overall health of the U.S. economy by considering people’s feelings about their finances and their optimism (or pessimism) regarding broader growth. Given that U.S. consumer spending comprises as much as 70 percent of the Gross Domestic Product, this consumer sentiment survey is crucial in determining the possibility and timing of a recession.
When people are pessimistic about the economy or their own situation, those feelings can manifest into actions—or inactions. Households could buy less and save more in anticipation of hard times ahead. That aggregate retrenchment can manifest a sour reality. Similarly, the converse is true. Improved sentiment, even exuberance, may not stimulate economic activity. But it does reduce (or at least defer) the stalling out of households boycotting discretionary spending. That is not great for an economy still battling high inflation, but it is welcomed news for those holding out for a soft landing. (A “soft landing” is a slowdown in economic growth that avoids recession. It is the goal of a central bank, like the Federal Reserve, when it raises interest rates to prevent overheating and reduce inflation.)
Still, don’t get too excited just yet about skirting a recession. The MSCI is rallying, but it remains at a status historically consistent with a recession. The current grade of 72.6 is below the MSCI’s level at the start of five of the six recessions since the index’s 1966 inception.
It’s not just consumers who are more optimistic about the future. The National Association of Active Investment Managers (NAAIM) members hold a higher allocation of equities today than they did in October 2022. The S&P 500 hit a low in October 2022.
Above is the NAAIM Exposure Index, which represents the average exposure to the U.S. equity markets reported by their members. You can see that the Exposure Index (thus equity allocations) declined as the stock market went down and increased as the stock market rose.
I don’t know any NAAIM members personally, but let’s acknowledge that this index is as good a reason as any not to hire a financial advisor that hangs their hat on investment performance. This embarrassment for my industry aside, it is yet another signal that people (whether regular households or professional investors) expect that soft landing.
Currently, the landing does look soft. The Atlanta Fed GDPNow model tracks GDP growth for the current quarter at 2.4 percent. For comparison, the annual growth rate of U.S. GDP from 1948 until 2023 was 3.13 percent.
But that is currently. The two-year and 10-year Treasury yields have been inverted since March 2022, leading indicators continue to collapse, and manufacturing has declined for eight consecutive months.
Adding to the dangers, the Federal Reserve is scheduled to meet Wednesday, July 26, a couple of days after this article will be published. There is a 96.7 percent chance the Fed will raise interest rates yet again. The federal funds rate is expected to increase from a range of 5.00-5.25 percent to 5.25-5.50 percent. The Fed often reminds us that increased interest rates affect the U.S. economy with “long and variables lags.” In other words, it should take roughly 12 to 18 months for the Fed’s work to filter into the economy. The Fed first raised interest rates this cycle by one-quarter percentage point on March 17, 2022. Then one-half of one percent on May 5, 2023. And although this wasn’t the last of it, then there was a series of four hikes, each three-quarter of one percent, starting June 16, 2023—13 months ago. The economy is going to start feeling those hikes.
The current economy looks good in many respects. But that doesn’t mean it has landed. It’s difficult to consider these things and expect that we avoid a recession. My guess is that investors will get lulled by the Siren Song of a soft landing only to crash their ship full of investments into a stock market cliff.
My investment portfolio looks more like the NAAIM Exposure Index today than in October 2022. Fortunately, in October 2022, my portfolio still looked more like NAAIM’s Index today than back then. So, yes, I’m bullish. But I’m a scared bull. The best I can do now is to put in my earplugs, ignore the sound of a rapid shift in consumer and investment sentiment, and stay focused on the data.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
