Yesterday: Investigating the Health of the U.S. Consumer

Echoing the Beatles song “Yesterday,” the U.S. consumer’s troubles “seemed so far away” just as of last fall.

Unfortunately, the narrative has begun to transition to a less optimistic shadow hanging over the consumer, as 79% of respondents¹ to the June Consumer Sentiment Survey by the University of Michigan expressed bearish sentiment about the economy for the year ahead. To put things into perspective, the U.S. consumer emerged from the COVID-19 pandemic in a relatively healthy financial standing with a strong balance sheet and low leverage levels. Additionally, as the Federal Reserve and the U.S. government injected unprecedent levels of monetary and fiscal stimulus into the economy to combat COVID-19, the consumer found itself in a tight labor market with rising wages, higher levels of wealth, improved creditworthiness, and an increased ability to spend. As a result, the consumer still remains daring, as evidenced by elevated levels of spending with an increased reliance on revolving credit, recently rising 13.4% YoY to an all-time high of $1.1T. But with inflation rising to 9.1% in June and recently hitting a forty-year high though, rising prices are beginning to have an impact and are top of mind for many. In fact, 49% of consumers² now cite inflation as the top reason for the erosion of their living standards.

Consello’s Research Team has embarked on developing a proprietary scorecard, the U.S. Consumer Health Assessment Scorecard (see page 3), to unpack these developments and gauge the health of the U.S. consumer at present and its future implications for corporates. The scorecard is formed by assessing the current state of the following ten key factors: inflation, consumer confidence, business sentiment, personal savings rates and indebtedness, equity market performance, liquidity in the financial system, housing, spending trends, labor market trends, and consumer creditworthiness. This paper provides implications for a variety of corporates in the consumer facing sectors, including companies in the consumer discretionary and retail sector, paper and packaging, consumer staples, and financials/real estate. Indirectly, we also see potential implications for technology, industrials, and materials companies.

Based on our preliminary analysis, we would characterize the current U.S. consumer as one who is still balance sheet healthy, financially resilient and supported by a strong labor market. However, this same consumer is on what we believe to be a potentially unsustainable spending path, is pivoting in order to adapt to a rapidly changing economic environment, and is starting to more acutely sense the increasing uncertainty of the future.

The consumer is readjusting to this new economic environment, but the process is taking time, as shown by spending levels that remain high (retail sales up 8.4% YoY in June 2022 and well above pre-COVID levels), with a noticeable reallocation of resources away from savings and toward spending. While personal income has risen 13.7% versus pre-COVID³, the personal savings rate has fallen by 27.4%. Similarly, savings rates were as high as 30.5% in April 2020, when the IRS issued the first economic impact payment (EIP) of $1.2k per eligible person, but this rate has now fallen back to approximately 5% and remains below long-term historical levels. These factors have resulted in consumer behavior that is somewhat less than prudent, such as higher credit utilization. Admittedly, there is a psychological element to the observed elevated spending patterns stemming from the social isolation experienced during COVID-19 lockdowns and social distancing measures. As a result, the consumer is now spending more on dining out and travelling in an effort to compensate for missed experiences during the pandemic. The consumer is potentially making other bold decisions, as observed by the rising quit rate, which is materially elevated versus pre-COVID levels. While this signals strong optimism in terms of labor market opportunities and the ability to find a job, it also coincides with a challenging macro backdrop. Gas prices, up 30% YoY⁴, are a particularly meaningful headwind. To the positive, housing remains robust, and the home-owning consumer is feeling wealthier. These dynamics, together with a strong labor market, explain some of the discrepancy between general consumer sentiment, which has deteriorated, and actual consumer spending behavior. The dichotomy has created an environment where fear for the future resilience of the U.S. economy and an expectation of continued financial opportunities can coexist.

In conclusion, we believe that the U.S. consumer’s financial profile remains moderately healthy given the strength of their balance sheet versus other economic downturns observed, such as the Global Financial Crisis (GFC). With the labor and housing markets remaining strong and consumer leverage at historically low levels albeit increasing, the consumer remains resilient for now, but their buffer may be decreasing. Today’s consumer faces abnormal economic times, defined by unprecedented inflationary pressures and stock market volatility that are heavily impacting their balance sheet, just as federal stimulus programs have started to run off. In addition, US GDP shrank for the second consecutive quarter in July, meeting the technical criteria for a recession. Meanwhile, the CEO Confidence Index, which acts as a method of evaluating the health of the U.S. economy from the perspective of U.S. CEOs, has now fallen to a decade low. While there are some schools of thought suggesting that inflation may already be moderating, we still see risks to the consumer health. As prices are likely to stay elevated in combination with wage rate increases below the rate of inflation, these patterns may further lead to spending pattern shifts and some cutback on discretionary items.

---

Consello’s Predictions

As the consumer grapples with the aforementioned conflicting economic factors, they are becoming less confident given high inflation and economic uncertainty. Likewise, the consumer’s financial resilience is also incrementally softening as observed by falling savings rates, rising revolving debt, and lower stock portfolios. This is particularly relevant for people with lower income. Our analysis of the ten macroeconomic factors related to the health of the consumer provides insights that may be relevant to an audience of various companies and sectors, cited above.

• An increasingly less confident consumer may see their financial resilience weaken.
  The broad conclusion, based on our research, is that while the consumer remains moderately healthy today, they are gradually weakening and becoming less confident as we enter a future period of heightened economic uncertainty. With the Fed hiking rates, we expect the labor and housing markets to cool off, potentially decreasing the consumer’s financial buffer against a downturn. As a result, we predict that consumers’ financial resilience and creditworthiness may likely worsen.
• Consumer spending may slow, leading to a reduced corporate revenue outlook.
  While discretionary spending remains elevated today, it will likely adjust downward as inflation continues to take a larger share of households’ disposable income. A pullback in spending will have an impact on the corporate sector and on the overall economy that faces a near-term slowdown. We predict that revenues for select corporates may stagnate or even contract. This may be especially pronounced among consumer-facing businesses, while other sectors like industrials or technology may also feel the negative impact. Businesses are already seeing demand soften and CEO confidence has dropped, and we expect discretionary spending to pull back further as consumers’ purchasing power erodes due to high inflation, posing a threat to business growth in the near-term.
• Unemployment rates to increase.
  We believe that we are in the beginning phase of a potential economic slowdown and one that could lead to an inevitable need to reduce costs in order to manage earnings. Slowing economic demand could therefore lead to a reduction in the labor force and ultimately drive higher unemployment. And even for those employed, the further reduction of wage increases will only magnify the effects of inflation at its current levels.
• Potential for additional downward revisions in Street estimates.
  These dynamics may make the jobs of corporate C-suites and investor relations (IR) teams more challenging given the amount of uncertainty and the difficulty in forecasting and providing adequate guidance. While economic slowdown fears are abundant, we could see potentially more Analysts lowering their growth estimates for 2H22 and 2023. On the business front, inventory management, expense management and pricing decisions will become even more important to adjust to a new normal.

We acknowledge that commodity prices and freight rates, which have had some historical correlation with inflation, have eased, but they still remain at elevated levels relative to pre-COVID. Given this, it is possible that inflation may lessen earlier than expected. However, we remain committed to our conclusion given that many companies have already passed along input costs to consumers through pricing and are unlikely to lower them now that a new pricing level has been established. In addition, as the Federal Reserve’s rate hikes flow through the economy, each hike taking around 12 months to take full effect, liquidity will tighten, and larger purchases will become less affordable for consumers, reducing spending ability. This tightening of liquidity will likely be amplified by the Federal Reserve’s intent to reduce its balance sheet in the near term, with monthly reductions of holdings of Treasuries and agency mortgage-backed securities reaching up to $95B by September 2022. The yield curve appears to be capturing the implications of the Fed’s monetary policy, becoming increasingly flattening compared to the start of the Fed’s hiking cycle, which began in March 2022. Rising shorter-term yields signal that investors believe that the Fed’s forward guidance regarding its hiking cycle is credible, while longer-term yields hint at a potential economic slowdown.

Consello Scorecard

Below is a scorecard of our findings that measures current U.S. consumer health across ten broad macroeconomic factors. Each factor is graded on a scale of one to ten, one being highly bearish, ten being highly bullish, and five being neutral. To determine each factor’s individual score, we analyze each factor and compare it to historic peaks and troughs, allowing for a more holistic and qualitative approach.

Adding the individual scores for each factor, we arrive at a total score of 60 (out of 100). We view a score of 60 as a snapshot in time capturing that today’s U.S. consumer is still somewhat healthy, while risks to the downside exist. In particular, confidence levels are low, but spending continues regardless of significant inflation, while housing and the labor market remain strong. The consumer is still digesting inflationary pressures and remains a creditworthy borrower. However, we acknowledge that this score has declined versus the past two quarters, and we believe that there is further risk to the downside over the next six to twelve months.

For reference, a time period with a materially higher score was Q4 ’19, the last quarter of the longest economic expansion in U.S. history. Conversely, a time period in history with a materially lower score was Q1 ’09, when 30% of mortgage holders felt underwater on their mortgage⁵, unemployment was high, and the delinquency rate was elevated.

---

A Deeper Dive

Below we take closer look at the economic and market data underlying our scores.

Inflation

Inflation remains well above the Federal Reserve’s longer-run goal of 2% and is a significant hardship for the U.S. consumer. The June CPI print of 9.1% YoY was the fourth consecutive print that was an upside surprise versus consensus estimates and is the highest CPI print on record since November 1981. The increase in prices in June was broad-based, with energy, food, and shelter being prominent contributors. The consistent sequential increase in shelter prices is of concern, given that shelter is associated with a greater degree of price stickiness and makes up about a third of the CPI.

The U.S. consumer is highly concerned regarding rising inflation levels. The July University of Michigan Consumer Sentiment survey found that consumers expect prices to increase by 5.2% in the next year and by 2.8% over the longer-run, which is above the Fed’s longer-run target of 2%. As noted earlier in this paper, ~50% of respondents to the survey cite inflation as the main reason that their living standards have eroded. This sentiment is supported by real average hourly earnings, which declined by 3.6% YoY in June.

While the Fed has embarked on a rate hiking cycle to combat inflation, international events continue to place upward pressure on prices at home. For example, the Russia-Ukraine war has increased oil prices while COVID-related lockdowns in China continue to impact supply chains. ISM manufacturing surveys confirm the impact of these events, with the majority of manufacturers indicating that they continue to face elevated input prices.

*Core Indices exclude the impact of food and energy
**PCE stands for Personal Consumption Expenditure Price Index. It is a measure reported by the Bureau of Economic Analysis used to estimate consumer spending

---

Consumer Confidence

The U.S. consumer has become increasingly concerned regarding the current and future state of the U.S. economy, as indicated by recent consumer sentiment and confidence surveys. The University of Michigan Consumer Sentiment survey declined to a historic low in June and remained near this low level in July. Notably, 49% of respondents cited inflation as the top reason for why their living standards have eroded.

However, inflation expectations for the year ahead did lessen this month, with consumers expecting prices to be up by 5.2% rather than the month prior’s expectation of 5.3%. Consumers remain highly cognizant of the impact of elevated gas prices on their wallet, although median expectations for short- and long-term changes in the price of gas have fallen to under one cent, indicating that consumers do not expect prices to rise much further. Still, the burden on consumers is heavy and around half of surveyed respondents raised the issue of gas prices.

Consumers continue to have a positive view on the current state of the labor market. The Conference Board July survey published that 50.1% of respondents view jobs as plentiful, down from the historic high of 57.2% reported in March 2022. The University of Michigan survey has reiterated the Conference Board survey’s message that consumers are feeling more concerned about the labor market’s future health with around 40% of respondents expecting unemployment to rise in the year ahead, up from 14% a year ago.

---

Business Sentiment

As workers have become scarce, employers have increased wages and salaries, with a historical high of 70% of NABE survey respondents having done so in Q1 2022. This is the seventh consecutive survey where wages have increased and the fourth consecutive survey where no respondents reported wages declining at their firms – indicating just how tight the current labor market remains.

In addition to rising wages, U.S. businesses have been digesting rising input material costs, with a historical high of 75% of businesses experiencing material costs increase in Q1 2022. Companies have been able to pass along some but not all of these costs to consumers as material costs have risen faster than price hikes. In fact, only 15% of companies have passed on all or nearly all of the cost increases to customers and 45% have passed on some cost increases⁶.

Businesses are already seeing demand soften and expect discretionary spending to pull back further as consumers’ purchasing power has eroded due to high inflation, posing a threat to business growth in the near-term.

The CEO Confidence Index has recently dropped to almost a decade low. Likewise, the NFIB Small Business Outlook for general business conditions six months from now is also at an all-time low.

* The NABE Business Conditions Survey looks at how current business conditions, such as demand, prices, costs, wages, employment, and profit margin, are affecting NABE member firms.

---

Savings and Indebtedness

As noted above, consumer spending persists at an elevated level. However, while personal income has risen 13.7% versus February 2020 (pre-pandemic), personal savings have fallen by 27.7%. This combination has resulted in the savings rate declining from 7.3% in February 2020 to 4.7% today.

This is a significant difference from the record high savings rate of 30.5% seen in April 2020, when the IRS issued the first economic impact payment (EIP) of $1.2k per eligible person. This was then followed by two more EIPs, with the first arriving in December 2020 and January 2021 and the second arriving in March 2021. The U.S. personal savings rate increased on a sequential basis, rising to 12.4%, 17.7%, and 23.9%, respectively, in each of these EIP months.

Following the end of EIPs and the Child Tax Credits (monthly payments sent from July 2021 to December 2021 to ~39M households or 88% of children in the United States⁷), the personal savings rate declined. Looking at the Federal Reserve’s quarterly data on the distribution of household wealth in the United States, it can be seen that lower income households, specifically the bottom one-fifth of the income distribution, are spending down their cash savings. The bottom 20% have reduced holdings of cash by 22% when comparing Q1 ’22 levels to Q4 ’19⁸.

Combined with inflation pressures on the household balance sheet, in particular gas and grocery prices, the personal savings rate at the national level has declined as consumers are faced with higher basic living costs. In addition to spending down personal savings, the U.S. consumer has become more reliant on revolving credit. Revolving consumer credit outstanding has increased on a month-over-month basis for 14 consecutive months and is now above pre-pandemic levels.

The elevated reliance on revolving consumer credit, in addition to the depletion of savings in order to maintain spending
levels, is of concern. In light of the Fed’s hiking cycle, the prime rate has risen to 4.75%⁹ from 3.25% in March 2022, indicating that credit card loans, auto loans, and personal loans are becoming a heavier financial burden for consumers. Should the burden become too great, there is a material risk of consumer creditworthiness deteriorating and the U.S. consumer’s financial flexibility becoming limited. Taking a step back, rising rates, a slight cooling in housing demand, elevated consumer sentiment concern, and equity market declines paint an image of a U.S. consumer with eroding household wealth.

---

Equity Market Performance

The equity markets peaked on the first trading day of 2022. Since then, YTD, the S&P is down nearly 20% and the Nasdaq is down around 25%¹⁰. A combination of factors has led to a drop in performance since the beginning of the year. Inflation rates at 40-year highs have certainly spooked investors, with investors comparing today’s economy to the 1970s. Earnings estimates for 2H of 2022 and 2023 are also viewed with caution, with analysts and strategists suggesting Street consensus still needs a major reset. The drop in the stock market has negatively impacted consumer’s household balance sheets and the personal savings rate, creating further uncertainty.

---

Liquidity in the System

The amount of money in circulation dramatically expanded in the United States as a result of the emergency actions and extraordinary emergency measures implemented in response to markets becoming severely liquidity strained. Actions taken included: interest rate cuts of 1.5% by the Fed; quantitative easing in the form of massive amounts of debt repurchases initially set at a rate of $80B/month in Treasuries and $40B/month in residential and commercial MBS; lending to securities firms through the primary dealer credit facility; backstopping of Money Market Mutual Funds through the Fed’s Money Market Mutual Fund Liquidity Facility; expansion of the scope of repo operations; and international swap lines. The Fed also encouraged banks to lend by increasing direct lending to banks through the discount window and it also relaxed its regulatory requirements. To support financial stability, the Fed established two new facilities to increase the flow of credit to U.S. corporates – the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). The Fed also launched the Term Asset-Backed Securities Loan Facility to support asset-backed securities and set up lending to states and municipalities (through the Municipal Liquidity Facilities), along with small and middle businesses, amongst other programs.

The money supply, as measured by M2¹¹, has increased by $6.3 trillion since February 2020, the majority of which came from Fed programs ($4.7 trillion) and the rest from the banks, which translates to a 41% increase in the overall money supply. This elevated liquidity spurred massive spending and led to a quick V-shaped recovery of what is to remain one of the shortest recessions in U.S. history. Elevated liquidity and economic rebound, however, contributed to a dramatic increase in inflationary pressures, prompting the Fed to raise rates by 2.25% this year to stabilize prices, with further rate hikes expected this year. As a result of these actions and the emergency programs running off, the M2 growth rate has tapered significantly, with month-over-month growth declining from an average growth rate of 4.9% during peak M2 growth (March ’20 to May ’20) to its current rate of 0.1%.

More broadly, the Fed has set out to reduce its balance sheet by up to $47.5B each month from June through August, and then by up to $95B each month thereafter. One element of uncertainty coming out of this is that while these actions may stabilize inflation, there is widespread concern around their destabilizing influence on financial markets. Specifically, the Fed has acted as a market backstop over the pandemic and is now pulling back at an unprecedented pace in a period of heightened anxiety around inflationary pressures, raising rates despite recessionary fears. This has the potential to cause high degrees of market volatility and overall financial and economic uncertainty.

---

Housing

During the pandemic, the housing market was supported by significant tailwinds such as low rates, increased demand for suburban living, favorable demographics, and a limited supply of available homes. Prices have risen by ~20% on a YoY basis and ~40% versus pre-COVID¹². While housing starts and building permits indicate an overall trend of upward momentum, showing that more supply is being brought to the housing market, supply-chain issues, elevated building material costs, and difficulty sourcing labor has slowed home builders’ ability to complete new housing units. The inability to meet demand with a significant increase in supply has contributed to housing market tightness.

However, the Federal Reserve’s rate hiking cycle is now acting as a cooling measure to the housing market. The rapid rise in the 30-year fixed mortgage rate from its historical low of 2.82% in August 2021 to its current rate of 5.75%¹³ has been accompanied by a decline in mortgage purchase applications. While some U.S. consumers may be priced out of the housing market due to rising mortgage rates, demand remains firm given the stickiness of single-family home prices at elevated levels.

Of note, the Case-Shiller Home Price Index indicated that there appears to be an initial slowdown in home prices, with only nine cities seeing prices rise faster on a month-over-month basis. Of those nine, five of them are located in the South (Atlanta, Charlotte, Dallas, Miami, and Tampa).

---

Consumer Spending

Although consumer sentiment and confidence surveys indicate that the U.S. consumer is experiencing elevated levels of concern, spending remains strong with retail sales up 8.4% YoY. The composition of consumer spending has begun to shift. When COVID-19 initially spread across the nation, consumers shifted their spending to online shopping, home improvement, groceries, and motor vehicles and away from restaurants and bars, clothing, and brick and mortar shopping. Now, two and a half years into the pandemic, consumers have begun to shift back to earlier spending habits, with growth in spending on home improvement slowing and spending on restaurants and bars rising.

The shift away from home improvement can be seen in the decline in spending at building-supply stores, which has fallen for three consecutive months, perhaps hinting at incremental cooling in the housing market. The return to services is evident through recent OpenTable high frequency data, which shows that the level of seated diners at restaurants in the United States has returned to pre-COVID trend. Daily airline travelers in the United States have also returned to pre-COVID levels, further illustrating the shift back to spending on services and experiences rather than goods. However, online shopping remains a significant alteration in consumer shopping habits, with online retail sales having increased by 57% versus pre-COVID (February 2020).

Gas stations are seeing highly elevated levels of retail sales, increasing by 66% versus February 2020 and by 49% YoY. Sales are growing rapidly on a month-over-month basis as well, with sales increasing by 4% in June versus May. This has largely been driven by rising gas prices, with the price per barrel currently sitting at $98¹⁴ (WTI crude oil future contracts) vs. the average February 2020 value of $51.

While consumer spending remains strong from a bird’s eye view, taking a more detailed look reveals some troubling signs. Retails sales have increased in nominal dollar amount by 29.3% versus February 2020, yet when adjusted for inflation sales have increased by just 13.4%. Consumers are willing to continue spending in the face of elevated inflation, and they are paying more for goods and services. So far, the consumer has been able to digest this combination, supported by wage and salary increases.

---

Labor Market

The U.S. unemployment rate has returned to pre-COVID levels, with the U-3 unemployment rate¹⁵ at 3.6% and the U-6¹⁶ reaching a historic low of 6.7% this June. In addition, nonfarm payrolls have almost fully recovered to levels seen in February 2020, right before COVID impacted the U.S. economy and led to extensive layoffs. Sectors that have not fully recovered back to pre-COVID levels include leisure and hospitality, government, and education and health services. Payrolls have increased for jobs in business services, as well as in trade, transportation, and utilities.

Continuing and initial claims also indicate that applications for U.S. unemployment insurance have returned to pre-COVID levels, signaling that the U.S. labor market is relatively tight. However, initial claims have ticked up slightly over the past month, likely due to certain companies laying off employees given elevated concerns over the macro outlook.

As the labor market has become tighter, employers have responded by raising wages. However, even though labor is in high demand, the labor force participation rate has not returned to pre-COVID levels. The tightness of the labor market has been worsened by the elevated number of jobs available and lower number of job seekers. Some of the people who have not rejoined the labor force include early retirees and those with family caregiving challenges. The number of job openings in the United States has been elevated and reached 11.3M in June. Interestingly, the quit rate is elevated versus pre-COVID trend, at 2.8% this May compared to 2.3% in February 2020, likely pointing toward confidence in the ability to find a new job.

---

Creditworthiness of the Consumer

We address consumer creditworthiness toward the end of the report as it is evaluated based on a variety of macro-related factors, making it a rather comprehensive metric. As a result, this section may reference several conclusions and data points that we have already presented. When evaluating consumer creditworthiness, factors to consider include: 1) the level of household income and its relative stability; 2) existing wealth; 3) current indebtedness; and 4) repayment history and early signs of potential deterioration in repayment. It also helps to have a view of the broader macro environment, which over time can impact individual members of society. Overall, we believe consumer creditworthiness remains healthy with low levels of leverage and a high degree of balance sheet buffers relative to historical levels. However, we believe there are some early signs that show incremental weakness that we review below.

As mentioned, the U.S. consumer is operating in a tight labor and housing market. Wages are rising, job opportunities are more plentiful than pre-pandemic, and home prices are elevated, providing homeowners with higher levels of wealth. Consumers are also optimistic regarding the ability to quickly find a new job, as suggested by the quit rate exceeding pre-pandemic levels. This is all the more impressive given that the consumer is indicating concern about the probability of a recession in the next twelve months and that the technical criteria for a recession has already been met. While income levels have been rising and the labor force’s bargaining power has been high, we think creditworthiness may erode as the stability of income likely decreases. Specifically, given high levels of inflation and the Fed rate hikes, there is a high degree of uncertainty around how sustainable current labor market dynamics are, casting a shadow over income prospects. This, factored with heightened levels of spending that are increasingly coming from additional credit taken, as shown by the overall increase in consumer credit in the economy, requires further caution.

Wealth plays a big part in determining creditworthiness and, as we stand today, we are observing a tale of two cities in which on the one hand, the stock market has eroded 19% of its value YTD¹⁷ (based on the S&P 500 index) and at the same time housing has continued to boom. To put this into context, over half of U.S. households are directly or indirectly invested in the stock market, resulting in a direct impact on the overall level of household wealth. This year, equity market declines have fully offset real estate price appreciation, signaling an overall negative shift in wealth creation trends. When we combine this with overall savings rate declines down to pre-GFC levels, we believe that the consumer financial buffer is decreasing. However, overall leverage remains low relative to history, despite rising utilization of consumer credit lines.

We observe an interesting difference in trends in mortgage origination rates for outstanding credit scores (>760 FICO score) versus subprime origination (<620 FICO score). Specifically, there has been a noticeable decline in mortgage originations for excellent credits off the 2021 peak, as shown below. Meanwhile, the rate of origination for subprime mortgages has not reached prior peaks last seen during the GFC and has stayed within a relatively stable band. However, over the past decade credit scores have trended upwards, meaning the level of FICO upgrades has exceeded FICO downgrades, resulting in an overall higher average FICO score. Finally, we analyzed the delinquency and charge-off rates on consumer loans issued by the banks, using Federal Reserve seasonally adjusted data. Both charge-offs and delinquency rates still remain near all-time lows, signaling that the consumer’s ability to repay credit card debt remains relatively strong. However, given the rising level of economic uncertainty, we may see a modest reversal of these trends.

---

Appendix

Scoring Breakdown

Below is a detailed explanation of the reasoning behind each score, further detailing Consello’s three-part methodology noted earlier and the assessment commentary stated in the table above.

Inflation: 2

We assign a score of 2 given the highly elevated level of inflation (40-year high) and the pinch being felt by consumers, while acknowledging that we have before seen even greater and more consistent levels of inflation.

For reference, a score of 1 would apply to 1946 to 1948, when the CPI reached up to 20% YoY following the end of WWII. A score of 10 would be applied when inflation meets the Federal Reserve’s longer-run goal of 2%. When inflation is above the Fed’s goal, it tends to implement contractionary monetary policy and when it is below its goal, the Fed tends to implement expansionary monetary policy.

Consumer Confidence: 3

We assign a score of 3 given the University of Michigan Consumer Sentiment survey reaching a historic low in June and the alignment of consumer expectations in the Conference Board survey. The University of Michigan survey demonstrates an elevated concern for business conditions in the year ahead while accounting for the tight labor market conditions helping to buoy the U.S. consumer.

For reference, a score of 10 would be applied when consumer confidence was at levels seen in February 2020, prior to the pandemic and at the end of the longest period of economic expansion in U.S. history. A score of a 1 would be applied when the University of Michigan survey and the Conference Board survey trend downwards together for a material period of time, which we define as at least six months. For example, the period from August ’07 to June ’08.

Business Sentiment: 4

We assign a score of 4 as demand is softening as a result of increased consumer fears of recession and consumer purchasing power is eroding, combined with elevated input costs and higher wages.

Given the individual sector dynamics across business segments, a time period with a score of 10 is difficult to state with complete conviction. With that in mind, we reference Q1 ’19 as a period when a score of 10 would have been applied. This time period was near the peak of the longest economic expansionary period in U.S. history. All NABE survey respondents for Q1 ’19 expected economic expansion to continue for the next 12 months. An increasing number of employers were seeing rising sales and higher profit margins as well. Tariffs were of concern and impacting material input costs, but monetary policy was becoming more favorable and employment growth was widespread. A score of 1 would apply to Q1 ’09 and Q2 ’20.

Savings and Indebtedness: 5

We assign a score of 5 given that the personal savings rate has fallen below post-GFC trend of ~6% and revolving consumer credit outstanding has increased, while still accounting for the overall increase in personal income versus pre-pandemic levels. For reference, a score of 10 would be December 2020 to March 2021, when the savings rate was highly elevated relative to historical levels and revolving credit usage was below trend. A score of 1 would be applied if personal savings deteriorated further beyond post-GFC trend, revolving consumer credit outstanding increased materially beyond the pre-pandemic trend, and overall personal income consecutively declined month-over-month and on a YoY basis.

Equity Market Performance: 5

We assign a score of 5 given the YTD performance in the S&P 500 of -19% and in the Nasdaq composite of -28%¹⁸, while acknowledging that from a historical lens equity markets are still near all-time highs and up significantly versus pre-COVID. The score also acknowledges that as the Fed continues to tighten monetary policy in response to inflation, the market will digest this reduced liquidity accordingly. Fed funds futures provide legs for this assumption, indicating that the Street expects the Fed funds rate to be 3.5% at YE22¹⁹.

For reference, a score of 10 would apply between November 2020 and December 2021. November 2020 is when the S&P 500 returned to pre-COVID levels and then continued to rise through YE21. A score of 1 would apply to March 2020, when the S&P 500 declined by ~30% month-over-month and the VIX index reached a historical high.

Liquidity in the System: 7

We assign a score of 7 for liquidity in the system given the extraordinary rise in the money supply. However, we acknowledge that the rate of injection of liquidity into the system has slowed in recent months. In addition, as the Fed has implemented their hiking cycle, the cost of borrowing cash has risen.

For reference, a score of 10 for liquidity would apply to the period from March 2020 to May 2020. During this period, the M2 money supply rapidly increased by $1.8T or an average monthly growth rate of 4.9%, far above the average monthly growth rate from 2017 to 2019 of 0.4%. The Federal Reserve’s balance sheet as a percentage of U.S. GDP significantly expanded, from 19.2% in February 2020 to 33.3% by May 2020. A score of 1 would apply to late March 2020. Trading conditions indicated significant liquidity strains, as seen by the BBB U.S. Corporate spreads widening by 488 bps on March 25, 2020²⁰.

Housing: 8

The housing market remains tight, supported by tailwinds such as increased demand for suburban living, favorable demographics, and a limited supply of single-family homes. However, the rapid rise in the 30-year mortgage rate has been accompanied by a decline in mortgage purchase applications. We assign a score of 8 given the combination of these two factors, while acknowledging that single-family home prices remain elevated versus pre-COVID levels and on a YoY basis.

For reference, a score of 10 would apply to Q3 ’21. Home prices were highly elevated and rising, existing home sales were near ’05 – ’06 trend, pending home sales were elevated, construction spending on private residences reached a new all- time high during that time, and mortgage purchase applications were rising. A score of 1 would apply to Q1 ’09, a period during the GFC where 30% of mortgage holders felt underwater on their mortgages²¹.

Consumer Spending: 8

Consumer spending is strong, with retail sales up 8.4% YoY this June and 29.3% vs. February 2020 (pre-COVID). Spending is shifting back to pre-pandemic trend, moving away from home improvement and back toward restaurants, bars, and travel.

We assign a score of 8 given the YoY and versus pre-COVID growth in retail sales, while acknowledging the impact of inflation. For reference, a score of 10 would be applied when retail sales data was strong on a YoY basis and repeatedly so for consecutive months. Sequential monthly improvement would also be on a positive overall trend and not decelerating in growth consistently on a monthly basis. For example, fall 2021 would be scored a 10. A score of 1 would be applied when retail sales were contracting on a YoY basis and on a negative overall trend sequentially on a month-over-month basis. An example of this in history would be October to December 2008.

Labor Market: 9

We assign a score of 9 given the extraordinary tightness of the U.S. labor market, which has translated into higher wages and salaries for workers and an elevated number of job vacancies. The participation rate remaining below pre-COVID levels adds further pressure to the job market as workers remain on the sidelines. However, we acknowledge that payrolls have not yet fully recovered to pre-COVID levels and that initial unemployment claims have moved upwards over the past month.

For reference, a score of 10 would apply to March and April 2022. The U3 unemployment rate was at 3.6%, almost fully recovered to the February 2020 level of 3.5% and below the near-term historical average. Companies reported that they were continuing to raise wages and salaries and average hourly earnings were increasing by ~5.5% YoY, which is above the pre-COVID 2017 to 2019 average of 3% YoY. Initial job claims continued to fall and returned to pre-COVID levels. Taking a longer-term perspective, the jobs quit rate was 2.9%, hovering near its historical high of 3.0% reached in Q3 ’21, indicating the U.S. worker’s confidence in the economy. A score of 1 would apply to Q1 and Q2 of ’09.

Consumer Creditworthiness: 9

We assign a score of 9 for the creditworthiness of the consumer as we believe creditworthiness remains strong given that consumer leverage remains low, the labor market is favorable, personal income is increasing, home equity levels are elevated and repayments remain strong. However, rising inflation is eroding consumers’ purchasing power and the equity market’s response to the Fed pulling back the punch bowl has impacted consumers’ net worth.

For reference, a score of 10 would apply to Q4 ’19. Home price growth was stable from 2016 to 2019, and while the post- GFC labor market recovery was quite prolonged, by Q4 ’19 the employment-to-population ratio had returned to pre-GFC levels. The Fed had entered a regime of lower rates vs. prior periods, making credit more affordable for the consumer, and delinquency rates were low. A score of 1 would apply to Q1 ’10. Home price growth was negative for 11 consecutive quarters, the U-3 unemployment rate was at 9.9%, and delinquency rates were significantly elevated at 4.7%.

---

Additional Charts

---

¹Joanne Hsu, PhD (June 24, 2022). Preliminary Results from the June 2022 Survey, University of Michigan
²Joanne Hsu, PhD (July 15, 2022). Preliminary Results from the July 2022 Survey, University of Michigan
³Pre-COVID is referencing the February 2020 personal savings level in this sentence
⁴WTI crude oil future contracts as of 7.15.2022 at market close (Bloomberg)
⁵Tom Rosentiel (February 19, 2009) One-In-Five Homeowners Feels “Underwater” On Mortgages, Pew Research Center
⁶National Association for Business Economics (April 2022). Business Conditions Survey, NABE. https://nabe.com/NABE/Surveys/Business_Conditions_Surveys/April-2022-Business-Conditions-Survey-Summary.aspx
⁷IRS (May 17, 2021), Treasury announce families of 88 percent of children in the U.S. to automatically receive monthly payment of refundable Child Tax Credit
⁸Alexandre Tanzi, (June 21, 2022) At Bottom of Income Ladder, Americans Burned Through Extra Cash, Bloomberg
⁹As of 7.15.2022 at market close (Bloomberg)
¹¹M2 is a measure of the U.S. money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers’ checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds.
¹²Case-Shiller 20-City Home Price Index, FHFA U.S. House Price Purchase Index
¹³As of 7.15.2022 at market close (Bloomberg)
¹⁴As of 7.15.2022 at market close (Bloomberg)
¹⁵The U-3 unemployment rate is the most commonly reported rate in the U.S., representing the number of unemployed people actively seeking a job
¹⁶The U-6 rate includes discouraged, underemployed, and unemployed workers in the country.
¹⁷As of 7.15.2022 at market close (Bloomberg)
¹⁸As of 7.15.2022 at market close (Bloomberg)
¹⁹As of 7.15.2022 at market close (Bloomberg)
²⁰Referencing ICE BofA BBB US Corporate Index Option-Adjusted Spread, sourced from FRED by the St. Louis Fed
²¹Tom Rosentiel (February 19, 2009) One-In-Five Homeowners Feels “Underwater” On Mortgages, Pew Research Center

About the Authors