Stock Market May Be Overpriced Due To Consumer Weakness

Includes: DIA, IWM, QQQ, SPY
by: Power Hedge


The Federal Reserve claims that inflation is well below its goal, however the price of necessities has increased much more rapidly than general prices.

There has been no real wage growth since the recession ended.

This is putting pressure on the ability of consumers to maintain discretionary spending.

Consumer spending accounts for approximately 70% of all economic activity in the United States; thus, the economy appears to be much weaker than believed.

The strong growth that the stock market appears to be predicting based on its current valuation might be difficult to achieve.

For the past several years, the Federal Reserve has repeatedly stated that inflation in the United States remains consistently below the central bank's official target of 2%. However, this is dramatically different from what the average person on the street is experiencing. These individuals represent the largest group of consumers in America and thus the much higher inflation rates that they are experiencing in their daily lives will directly impact the ability of Americans to consume.

One of the problems with the core inflation measures that the Federal Reserve Bank uses to determine monetary policy is that these numbers exclude items such as food or energy. However, for the average person, these items consume a substantial portion of their budgets. While energy prices have come down dramatically over the past twelve months, food prices have not. In fact, as Michael Snyder at The Economic Collapse Blog points out, the price of ground beef, the staple of many American diets, has doubled since the last recession. This statement is confirmed by the Bureau of Labor Statistics.

Source: U.S. Bureau of Labor Statistics

Ground beef is not the only food item that has increased dramatically in price since the Great Recession. According to the St. Louis Fed, the price of all food and beverage items in aggregate has been increasing since the last recession.

Source: Federal Reserve Bank of St. Louis

Thus, the average American has seen the amount that they need to spend in order to eat steadily rise since the last recession. This would not be a problem if wages increased over the same time period in order to compensate for the higher price of food. However, this has not been the case. According to the Federal Reserve Bank of St. Louis, median household income in the United States declined immediately following the recession but then began to rise.

Source: Federal Reserve Bank of St. Louis

However, this modest increase in the median wage has not been sufficient enough to result in increases in purchasing power, partly due to the aforementioned increases in food and beverage prices. In fact, according to the St. Louis Fed, the real median household income in the United States is now lower than it was during the last recession.

Source: Federal Reserve Bank of St. Louis

Thus, the average American household has lost purchasing power since the end of the last recession. This is likely to have a strong effect on the purchase of discretionary items. This is because the increase prices for non-discretionary items (food and beverages) has outpaced the general increase in prices overall. Please refer back to the second chart presented in this article. As that chart shows, the CPI for food and beverage items in isolation increased from 218.030 in June 2009 to 246.269 today. This is an increase of 28.239. Meanwhile, here is the chart showing the general CPI over the same time period:

Source: Federal Reserve Bank of St. Louis

As this chart shows, the general consumer price index increased from 214.790 in June 2009 to 235.186 today, an increase of 20.396 points.

The conclusion to be drawn from all of this is that American consumers as a whole are being forced to devote an increasing proportion of their incomes towards the necessities of life. This leaves much less income available to purchase discretionary items.

However, the stock market does not reflect this reality. At the time of writing, the S&P 500 index, the most commonly used proxy for the overall stock market, trades at 2063.00. This is approximately 2.67% below its all-time high of 2,119.59. Considering that consumer spending accounts for approximately 70% of all economic activity in the United States, this would appear to be a very large disconnect.

The stock market as a whole also appears to be expensive on a historical basis. The most commonly used metric to measure relative market valuation is the Shiller P/E ratio. The Shiller P/E ratio is calculated by taking the average inflation-adjusted earnings of the S&P 500 over the past ten years and comparing them to the price of the index. As of the time of writing, the Shiller P/E ratio is 27.08, which as this chart shows is well above the historical average.


Thus, the stock market as a whole appears to be priced for considerably strong forward growth. However, the overall weakness in the consumer sector could make this quite difficult to achieve.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.