By Vivien Lou Chen
With an estimated 62% of American adults owning a stake in American companies, it is increasingly difficult to see how consumer demand can slow enough to reduce inflation.
U.S. stocks hit another round of record highs over the past week, further improving the sense of financial well-being for millions of Americans that could be complicating the Federal Reserve's battle against inflation.
Sixty-two percent of American adults have money invested in the stock market, either individually or jointly with their spouse through direct stocks, a mutual fund, 401(k) or an individual retirement account, according to published data this month by Gallup. This is little changed from 2023 and reflects a return to levels that largely prevailed between 1998 and 2008.
Even low-income households, with annual incomes less than $40,000, and middle-income households, with incomes up to $100,000, are getting a piece of the stock market action: 25% of low-income people and 65% of middle-income people. stocks, according to Gallup findings released May 15. The survey was conducted from April 1 to 22.
With so many people in the US benefiting from May's stock rally - which took the Nasdaq Composite COMP to an all-time closing high of 16,920.79 on Friday, and pushed the S&P 500 SPX to a record close of 5,321.41 on Tuesday - it is difficult to see how consumer demand can slow enough to reduce inflation.
Through Friday, the Nasdaq Composite, S&P 500 and Dow Jones Industrial Average were up 8.1%, 5.3% and 3.3%, respectively, during the month of May.
Next week offers new data that should provide more clues about the interaction between consumer attitudes and US inflation. The Conference Board's consumer confidence reading for May will be released on Tuesday, and Friday's releases will include an April reading of the Federal Reserve's preferred inflation gauge, known as the personal consumption expenditures price index.
Although a strong labor market and continued consumer spending are helping the United States avoid a recession, record prices on Wall Street may be fueling a negative feedback loop on the inflation front. This is despite the disconnect between how much money people theoretically make and how depressed many feel (which, according to a poll Harris conducted for The Guardian newspaper, is that the economy is already in recession and that the S&P 500 is down for the year, when it isn't Read: Stocks are up 12% this year, but nearly half of Americans think they're down What's happening and Dow Jones is trading above 40,000 for the first time. time, but fails to reach the milestone
The wealth effect is a behavioral theory that refers to the tendency to spend more when a person's wealth increases, even if their income does not increase. Some analysts, such as economist Torsten Slok of Apollo Global Management in New York, have drawn a direct link between the Federal Reserve's willingness late last year to cut interest rates three times in 2024, and consumer spending. which laid the conditions for higher inflation readings lower than expected in the first quarter.
Last December, Charlie McElligott, a cross-asset strategist at Nomura Securities International in New York, warned that the central bank's dovish policy shift in late 2023 would work against officials by awakening "animal spirits," or forces of market psychology that give investors greater confidence and can ease financial conditions in a way that may make inflation increasingly difficult to control.
This may have been the case, as first quarter inflation readings were higher than expected. Despite three months of little progress in reducing inflation to the central bank's 2% target, Federal Reserve Chair Jerome Powell surprised many observers on May 1 by considering the chances of a future rate hike low. guys. This was seen as opening the door to this month's stock rally.
See also: Why the post-Fed stock market rally raises new questions about inflation
"I think the wealth effect is certainly having an impact on consumers and helping to keep inflation elevated," said Brent Schutte, chief investment officer at Milwaukee-based Northwestern Mutual Wealth Management Company, which oversaw $302 billion in assets. in March. "I have always said that the last leg of inflation will be difficult and the stock market is working against this."
By phone, Schutte said, "We were very optimistic that inflation would come down, but now we think it will remain stagnant."
The question now is whether risk appetite - spurred by hopes of technology-driven productivity gains, as well as first-quarter corporate earnings results that have held up reasonably well - can coexist with inflation that is still slowing. remains above 2%.
The minutes of the Federal Reserve meeting from April 30 to May 1, released on Wednesday, showed a willingness to raise interest rates again if necessary to control inflation, somewhat moving away from Powell's message of 1 of May. A pair of Federal Reserve officials also referenced the wealth effect, saying some households were seeing strong gains in the stock market and rising home prices. Several policymakers questioned whether financial conditions were tight enough to affect demand and inflation.
Then on Thursday, a pair of S&P surveys found that inflation remained a sore spot for businesses this month. Those polls, along with the next day's reaction to the Federal Reserve minutes, were enough to contribute to a drop of 605.78 points, or 1.5%, in the Dow Jones Industrial Average DJIA, the worst percentage drop in one day in more than a year. . It took just one day for stock investors to regain their footing, and all three major stock indexes finished higher on Friday even after data from the University of Michigan showed consumer confidence had darkened in May due to concerns. about inflation.
Read: US consumer confidence darkens in May due to fear of higher inflation
"The market still has this Goldilocks view that inflation is going to go down, regardless of the fundamentals we see, and the Fed won't have to raise it," said Michael Reynolds, vice president of investment strategy at Glenmede, based in Philadelphia, which managed $45.4 billion in assets as of March for clients including endowments and foundations. "We think the likelihood that the Fed will have to raise rates is low, but not zero, and that it is higher than it has been because inflation has been stronger."
Last week's stock market rally is not helping to "cure" the inflation situation, Reynolds said by phone. Meanwhile, the United States could see a big increase in fiscal stimulus as a result of the November elections, and candidates from every major party will likely support it if the economy weakens, which should only exacerbate the wealth effect, he said.
As to whether the stock market can continue to rise even with inflation stuck above 2%, Reynolds' view is that if inflation accelerates towards the end of the summer, this would likely put rate hikes on the table. of the Federal Reserve. Plus, he said, the stock market would probably need to correct at some point, given how much investors have been hoping for lower borrowing costs this year. "We should see inflation holding steady," Reynolds said by phone. "So, absent a shock that hits demand hard, the question is: 'To what extent will it hold up?' "If it stays above 2%, but hovers around 2.7%, the Fed would probably claim victory. But 3.5% or 4% is not a victory, so the devil is in the details." Glenmede had been recommending that its clients underweight the stock. based on the view that there would likely be a recession in the United States, but the company has since moved that view to neutral, Reynolds said. Now, Glenmede's view six to 12 months out is that macroeconomic risks are relatively balanced and its clients should not make any significant changes to their portfolios before the November election, the strategist added.
-Vivien Lou Chen
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05-26-24 1201ET
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