The great American consumer is navigating inflation and just may save the economy from a recession

Published Sun, May 8 20227:50 AM EDTUpdated Wed, Jan 25 20234:30 PM EST

Christina Cheddar Berk @in/christina-cheddar-berk-b864404/

Wage gains may be starting to cool off, offering little comfort to consumers seeing prices for everything from gasoline to milk to plane tickets tick higher. As the Federal Reserve attempts to orchestrate a soft landing , cooling off the economy without throwing it into a recession, one of the key arguments being made by those who think it will be successful is how strong household finances are. By several measures, consumers are on solid ground. Goldman Sachs chief economist Jan Hatzius has called out the ratio of household net worth to disposable income, which is at a record high, and strong savings as one factor behind why Goldman thinks there is only a 15% chance the U.S. will slip into a recession over the next year. But others feel one cannot ignore the rapid rise of inflation, which sits at a 40-year high, and crumbling consumer confidence. Those factors could weigh on spending and prevent consumers from freely dipping into their nest eggs until they have to as real spending power erodes. These people argue that while consumers may want to splurge on travel and all the things the pandemic prevented them from doing, higher energy prices in the wake of the Russia-Ukraine war and eye-popping increases in grocery bills, will upset these plans. 'Unspent stimulus in the system' "Everyone's worried about economic turbulence right now, but there does seem to be some buffers in the consumer right now that can weather some of that," said David Tinsley, senior economist for the Bank of America Institute. Bank of America's data, which looks at both savings and checking balances as well as credit card spending, shows no signs that the consumer is slowing down. In April, total payments rose 25% year over year, while total credit card and debit card spending jumped 13%, according to a Bank of America report released Thursday. On a three-year basis, credit card spending per household in April is up 23.7%. Notably, the pace of spending is growing at a rate higher than inflation, so it's not just a function of higher prices for gasoline, food and other items. In March, U.S. consumer price inflation was at 8.5% . A fresh read on April prices is due out on Wednesday . Even among households earning less than $50,000, spending is higher than it was before the pandemic started, according to Bank of America. Lower-income households have held on to money from their stimulus checks and that is padding their savings. "There is quite a lot of unspent stimulus in the system, which is quite unusual," Tinsley said. He added, lower paying jobs have seen double-digit wage growth during the pandemic, which in some cases is as high as 15% to 20%. A shift in spending Spending has shifted quite visibly from goods to services, as consumers get back to eating out at restaurants, taking vacations and attending live events. Look at e-commerce companies like Etsy , Shopify and Wayfair . Shares were pummeled over the past week as the e-commerce companies offered weak forecasts. All three stocks are down at least 60% in 2022 and hit 52-week lows in recent trading sessions. Meanwhile, Bank of America said spending at airlines and travel agencies leapt 60% in April from the same month last year, while event ticket agency spending soared 140%. OpenTable recently called out strong early bookings for Mother's Day reservations. It said reservations made by April 18 for Sunday's holiday were up 39% compared with pre-pandemic bookings made in a similar period for the May 12, 2019, holiday. Retail industry trade group, the National Retail Federation, is projecting a record $31.7 billion in Mother's Day spending, based on a survey of 8,574 consumers in early April. The poll found 57% of respondents were planning to celebrate the day by dining out and 27% were planning to give Mom tickets to an event or other experience, which is the highest level this category has ever registered. The desire to leave pandemic restrictions behind and get out of the house was clear in Ticketmaster parent Live Nation 's first-quarter results on Thursday. It is expecting record concert attendance this year. "Early reads on consumer spending at our shows across the U.S. and U.K. also indicate fans continue their spending when they get to the show," said CEO Michael Rapino, during the company's conference call. "We had 2 million fans attend shows at our theaters and clubs in the first quarter, with average per fan revenue up 30% relative to Q1 2019. We also had four festivals over the past few months, totaling over 300,000 fans, with average per fan revenue up over 30% compared to their 2019 events." But Live Nation shares aren't reflecting this rosy outlook. The stock is down nearly 23% year to date. In a research note, Jim Paulsen, the chief investment strategist of the Leuthold Group, said soaring inflation and declining consumer confidence have historically weighed on consumer discretionary stocks. He noted that on a total-return basis, the equal-weighted S & P 500 Consumer Discretionary index has trailed the equal-weighted S & P 500 by almost 14% over the past 12 months. "As the word 'discretionary' suggests, when consumers are pessimistic, they tend to curtail spending propensities and raise savings rates, which is felt disproportionately by consumer discretionary companies," Paulsen wrote. "... Should inflation continue to surge and/or consumer confidence turns even more downbeat, discretionary stocks will likely disappoint even more." Keeping an eye on prices So while recent earnings calls were full of talk of vacations being booked and diners eating out, there are signs of increasing wariness. In recent surveys, consumers have shown they are growing more concerned about the economy and their finances and that's chipping away at their confidence. Morgan Stanley polled about 2,000 consumers from April 29 through May 2 and found 62% of them — an all-time high — were concerned about rising prices. Three months ago, that percentage stood at 56% in a similar survey the firm conducted. Half of those polled expect the economy to get worse in the coming months and about 26% expect their own personal financial picture to dim. Three months ago, 43% were anticipating a worsening economy and 23% expected household finances to deteriorate, Morgan Stanley said. The good news is households with income above $150,000 expect they will spend more money across all categories. And in aggregate, the outlook for spending on travel and restaurants has picked up from the previous survey, it said. There were parallels in a survey by Jefferies of 3,500 consumers in mid-April. In that poll, 54% reported feeling less confidence about their own finances, and there was a very high awareness of rising costs for gasoline , groceries and rent. About 72% of consumers told Jefferies they were trading down to less expensive groceries and household products, a bit more than a third were looking for less expensive apparel, and 24% said they were looking to dine at cheaper restaurants. And the vast majority expected prices to continue to climb. Jefferies also noted that higher income households held fairly consistent views with lower and middle income households. 'Incomes are shrinking' "People's incomes are shrinking," said Diana Furchtgott-Roth, an economics professor at George Washington University and former chief economist at the Department of Labor. Although wages are up 5.5%, prices are eclipsing those gains. Consumers may have savings, but "their real wages are being whittled away by inflation," she said, noting this is particularly true for consumers who need to borrow money to buy a car or have an adjustable rate mortgage. Furchtgott-Roth said she expects the Fed will need to move aggressively in an attempt to get inflation out of the economy. "We have never got inflation out of the economy by having a federal funds rate that's lower than the inflation rate," she said. Economists are expecting that consumer prices will remain high in this week's report, although prices could ease from last month. One encouraging sign came Friday in the form of falling prices for used cars. The Manheim Used Vehicle Value Index, which tracks prices of used vehicles sold at its U.S. wholesale auctions, declined 1% in April from March, marking the third straight month of declines from the first month of the year. It's possible that prices may be peaking, according to Paulsen. "... Versus historical norms, inflation is already very high, and confidence is very low," he wrote. "It seems more likely both are nearing a reversal. In addition, economic policies have been in a tightening mode for twelve months now (slower monetary and fiscal growth, a flatter yield curve, and a stronger U.S. dollar) — and it usually takes about a year to slow inflationary forces. That suggests inflation should soon moderate." If true, those beaten down consumer discretionary stocks be ready for a big reversal, Paulsen said.

Josephine Flood | CNBC

Wage gains may be starting to cool off, offering little comfort to consumers seeing prices for everything from gasoline to milk to plane tickets tick higher.

As the Federal Reserve attempts to orchestrate a soft landing, cooling off the economy without throwing it into a recession, one of the key arguments being made by those who think it will be successful is how strong household finances are. By several measures, consumers are on solid ground.