VIPs
- Consumer Expectations are a key variable that guides Wall Street’s thinking on consumer spending; household interest rate expectations peaked last October and have since fallen to a ten-year low raising a warning as major declines have preceded every recession since 1970
- Deteriorating labor market conditions are needed to confirm plummeting interest rate expectations signaling the end of the cycle; IHS Markit’s Flash PMI flagged declining private sector workforce prospects for the first time since January 2010
- According to Challenger, Gray and Christmas, August CEO job changes were the highest on record in data back to 2002; new leadership at the top can harken a reevaluation of business models and headcount reductions which act as a depressant on consumer spending
One-liners don’t get any better than, “Looks like I picked the wrong week to stop sniffing glue.” As you know, Lloyd Bridges nailed it beginning one of the most intense scenes in 1980s’ disaster spoof Airplane!, a parody of the Airport film series. Bridges plays a smoking, drinking and yes, glue-sniffing air traffic control supervisor increasingly overwhelmed by an air disaster in the making. The action quickly shifts to a flight attendant instructing passengers to, “get in crash positions.” Taking the directive literally (of course!), mayhem erupts as crazed passengers panic, flail and scramble over seats to end up where they think they’ll land if the plane does crash. Hilarious.
This timeless scene inspired today’s graph title. You’ll note the two series that are flying high — Consumer Expectations (the green line) and the XLY Consumer Discretionary ETF (the yellow line).
Those with sell-side experience know that equity traders liken the forward-looking component of the Conference Board Consumer Confidence index to a rough gauge for prospects in the Consumer Discretionary sector. The guidance is straightforward: more optimism = bullish; less optimism = bearish. We appreciate that consumers are a fickle lot and don’t always spend their “expectations.” That said, Consumer Expectations has major Street cred and is on the varsity of leading indicators that feed the U.S. Leading Index.
The Consumer Expectations index is comprised of three questions about near-term household attitudes. Respondents are polled on their forward views on business conditions, employment and income six months into the future. The survey also queries plans to buy auto and homes and take vacations within six months as well as expectations for stock prices and interest rates twelve months out. It’s this very last inquiry about interest rates we’ve plotted above in orange.
It would seem that investors aren’t the only ones who’ve shifted their views on the future direction of interest rates since late last year. Households have been right there with them. Those anticipating rising rates reaching a cycle high of 67.9% in October 2018. The baton hand-off was swift as those expecting lower rates began to spike sending the net (higher minus lower) interest rate expectations spread to a ten-year low of 12.4% in August. (Why yes, Jay Powell, last December’s rate hike was a policy error.)
Today’s latest Conference Board installment will update this metric with September data. Given what we know from the comparable figure in the preliminary September University of Michigan Consumer Sentiment survey (blue line), which tells the same tale, literally and figuratively, we expect to see a lower low.
This development was so striking to Richard Curtin, head of the Michigan survey, he created a chart of his own illustrating interest rate expectations, which you can see on his website (www.sca.isr.umich.edu). Of the September 13 release, he noted that “net declines in interest rates [were] more frequently expected at present than any time since the depths of the Great Recession in February 2009.” Look back in history, “ramp downs” of household interest rate expectations have been a precursor to every U.S. recession since 1970.
There is still one puzzle piece missing for voracious cycle chasers. And that’s labor. To translate the swing in interest rate expectations to an end-of-cycle signal, you need corroborating evidence from the job market. Cue this excerpt from yesterday’s IHS Markit U.S. Flash Purchasing Managers’ Index (PMI) for September (bolding ours):
“Latest data also signaled a sharper decline in backlogs of work, thereby suggesting a lack of pressure on business capacity. Some companies responded to subdued demand conditions by cutting back on staff hiring in September. The latest survey pointed to a drop in private sector payroll numbers for the first time since January 2010.”
Markit prides itself on its sample of companies that are not restricted to trade association membership, job title or company size. Its questionnaires are completed by C-suite executives, so the perspective is of a higher quality than other business surveys (think Institute for Supply Management) as the people called “boss” have direct control over their firms’ headcount.
We would add that job turnover in the C-Suite itself is spiraling upwards. According to Challenger, Gray and Christmas, private and public U.S. firms announced 159 CEO changes in August, the highest on records back to 2002. There are many reasons for new leadership, including installing someone capable of implementing needed changes such as layoffs who isn’t emotionally tethered to his or her workforce.
Are you long the XLY? If so, it pays to understand the link between falling consumer interest rate expectations and deteriorating job prospects. It’s essential you pull off a smooth landing for your portfolio when the turbulence is so bad you pick up old bad habits.