A Potentially Weakening Consumer And The Fed's Predicament

One aspect of the market's recovery since the financial crisis has been the strength of the consumer discretionary sector. Within the sector itself the retail industry group has outperformed both the S&P 500 Index and the overall discretionary sector itself. This strength could not occur over this long of a period without an improving consumer. The second frame in the below chart, however, shows the retail ETF has begun to underperform the discretionary sector this year and is a potential sign of a weakening consumer.

From The Blog of HORAN Capital Advisors

This weakness in the retail sector is further confirmed by the very poor University of Michigan Consumer Sentiment Index preliminary results reported on Friday. The sentiment reading of 85.7 was over six points lower than the August reading of  91.9 and below the low end estimate of 86.5. Econoday's summary of this report indicates this may put a potential Fed rate hike on hold later this month.

"Just when you think you've gotten through the week, consumer sentiment dives and, perhaps, tips the balance against a rate hike. The mid-month September flash for the consumer sentiment index is down more than 6 points to 85.7 which is below Econoday's low-end forecast. The index is now at its lowest point since September last year.

Weakness is centered in the expectations component which is down more than 7 points to 76.4, also the lowest reading since last September. Weakness in this component points to a downgrade for the outlook on jobs and income. The current conditions component also fell, down nearly 5 points to 100.3 for its weakest reading since October. Weakness here points to weakness for September consumer spending. Inflation readings are quiet but did tick 1 tenth higher for both the 1-year outlook, at 2.9 percent, and the 5-year, at 2.8 percent.

New York Fed President William Dudley himself has said he is focused on this report as an early indication of how U.S. consumers are responding to Chinese-based market turbulence. These results offer a rallying cry for the doves at next week's FOMC meeting."

From The Blog of HORAN Capital Advisors

The above chart also includes retail and business inventory to sales ratios. The business inventory to sales ratio (blue line) is far above the pre-2008 recession level and near the recession level prior to 2001. Also, the retail I/S ratio is near the levels reported in 2008. As noted above, the expectations and current conditions components of the sentiment report suggest weakness in the months ahead.

Consumer sentiment is not the only driving force of economic growth; however, the consumer does account for 70% of economic activity. The poor sentiment report does provide some Fed members with data that suggests a Fed hike should not occur this month. The Fed is in a corner for sure as we have noted in several recent blog posts. They seem to have missed an opportunity to raise rates a year or more ago. We will see if they raise them now in spite of the continued slow growth economy and a potentially weakening one.