By Thomas H. Kee Jr., Chief Economist, Stock Traders Daily
We have just been witness to an overshoot in real-world consumer sentiment and as is true in the case of all overshoots a correction now looms. Overshoots and undershoots happen regularly throughout economic cycles, but it is much more difficult to observe on a ground floor level unless you spend time on the ground floor. Economists with cubicle offices in tall buildings in large metropolitan cities who work in the traditional corporate world are often blind to these ground floor observations, but we may have just seen a major peak and if a reversal begins it could be material to the health of the consumer going forward.
Looking backwards to the last major undershoot, in the middle of 2009 my 'Random Walk' indicators suggested that the sentiment on the street was so poor that there was nowhere to go but up. Based on where normalized demand levels were as well the demand for investments at that time did not line up either. My proprietary work identifies where natural rates of demand are for investments in the US economy, and when we compare actual demand to normalized demand we can also see clear periods of overshoots and undershoots.
Not unlike the consumer based overshoots that we are witness to now, demand and even equity based valuation ratios seem to be overshooting as well, but that is a conversation for another day. Today's topic is the consumer, and the high end of the market certainly seems more sanguine than I have seen them since the middle of 2007, right before the most recent market meltdown.
Although the low end of the market does not share that enthusiasm, and that divergence raises a host of additional concerns, the basis for projections using our Random Walk model is contrarian as it identifies overreactions, either positive or negative, and attempts to identify opportunity afterwards. This is part of a group of indicators, and although I expect that someday this will hiccup, this part of our analysis has never been wrong.
Using an only partly scientific approach, which is mostly hands on, I have determined that shortly after the Market peaked about a month ago the sentiment on the street also seems to be peaking. This slight lag is normal, it even happened in 2009 where sentiment actually bottomed in the middle of 2009, shortly after the March 2009 low.
Interestingly, though, the high end is not as ready to make the big purchases as their face-value sentiment may actually suggest. They are paying up for the basics, movie tickets, dry cleaning, specialty retail, and food, but they are not stepping up to the extravagant purchases, nor are they likely to do so. For example, Tiffany's (TIF) revenues last quarter grew by a meager 1.6%, but Whole Foods Market (WFM) increased revenue by 13.6% by targeting the same customer. That high end customer is also buying expensively priced retail merchandise from Lululemon (LULU) at an extremely rapid pace, and today we will see just how robust that growth was year over year when LULU reports earnings.
My point here is that the high end is very happy, very willing to buy the higher end goods and services, and the price points for those items is actually increasing, but when the limits are pushed to the ultra high end like TIF we have seen enough hesitation for us to believe that a shift in absolute sentiment is also already occurring. I expect the trickle down impact of consumer sentiment to start to impact even the higher end food and specialty retailers soon, but I do not expect much change on the low end. Those consumers have not seen a spike in sentiment at all, they are still struggling, and this tale of two worlds will not change their pace of participation very much in my opinion.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.