A Message From America's Consumer: Protect Your Stocks!

by: Jeff Opdyke


The U.S. consumer is not as healthy as the media contend.

Revolving debt is back to pre-crisis levels.

A Fed rate hike would shrink the consumer's ability to consume, thereby slowing the economy.

Now is the moment to prepare for the possibility that the consumer rolls over.

Add exposure to the euro and European small-cap stocks.

Is the U.S. consumer the proverbial canary in the coal mine? Probably. But we'll get to that in a moment.

In the meantime… consumer confidence is riding high, or so says the University of Michigan's Survey of Consumers. April's 98 reading came in just shy of the highest reading since the Great Recession. Good news, if you're in the business of selling securities to Main Street. Not so good if you're in the business of looking ahead to where this hockey puck will soon be.

Happy consumers and higher stock prices walk together, hand in hand. Take a look… I've laid the UofM Consumer Sentiment reading atop the S&P 500 in five-year increments going back to 2000, to more easily show how sentiment rides shotgun with the market:

This last one overlaps a year or two simply to keep the five-year consistency.

The message is pretty obvious here: Consumer sentiment and the stock market are just mirrors that each reflect emotional exuberance or despair. Neither says a whole lot about the health of the economy at any given moment or where it's headed. If they did, then 2007 would have announced boom times ahead.

Maybe today's consumer jubilance isn't so much a sign of a robust economy, as some headlines have recently exclaimed. Maybe it's just a reflection of mindless spending that has easy-to-appease consumers feeling like life is OK.

But consider…

The dirtier side of the U.S. consumer

Behind the buoyant consumer sentiment, all is not as peachy as it would appear. A few facts to gnaw on:

  • As a group, consumers now owe more than $1 trillion on their credit cards, back near historic, Great Recession highs… proof that the consumer is living on borrowed money.
  • Freddie Mac's latest Cash-Out Refinance Report tells the story of consumers who are back to using their homes as an ATM to either live aspirational lifestyles or to make ends meet. Through the first three quarters of 2016, homeowners pulled more than $60 billion out of their houses through a cash-out refinancing or second mortgages and home-equity lines-of-credit. At the run rate consumers tapped into their home in those first three quarters, the full year, when Freddie Mac reports the data, will mark the highest level since 2009.
  • The average maturity of new-car loans is just shy of 67 months, the highest ever. Consumers without the income to afford the car they want are clearly stretching out their obligations to, again, live that aspirational life. And it's catching up to them because…
  • Subprime auto-loan and lease default rates are, says the New York Fed, at levels last seen just before the 2007-08 crisis.
  • Meanwhile, wage growth, after having rebounded from the Great Recession, has flat-lined in the 3% range, despite all the glad-handing about full employment (never mind that the jobs market continues giving us a great abundance of low-wage jobs while continuing to disgorge higher-wage, middle class jobs).
  • And atop this sundae of despair, retail sales are weakening - quite possibly a hint that all that debt accumulation is finally taxing the consumer's spending capacity.

Imagine what happens to the U.S. consumer…

If the Fed Raises Rates

Rate hikes don't happen in a vacuum, though too often, the Street seems to consider only the action it wants and not the reaction that results. But it's the reaction, at this particular moment, that could have some unwanted consequences.

Rates go up and credit-card minimum payments escalate. Payments due on home-equity lines-of credit increase. Auto loans become more expensive. Default rates begin to rise at a faster pace.

Effectively, the consumer's ability to consume shrinks, and that flows through to our consumer-dependent economy, given that $7 of every $10 is tied to consumer spending, says the St. Louis Fed.

So, I don't know that I would expect the Fed to keep raising interest rates. Doing so only hurts the consumer and slows the economy, directly opposite of what the Fed needs at this point.

I would not be surprised to see the Fed hold off on a rate hike for a while, maybe even lead Wall Street to that conclusion during press conferences after an upcoming Open Market Committee meeting, and in upcoming speeches from various Fed governors.

And I would not be surprised to see the stock market catch a clue, too, and begin to ratchet down expectations for corporate earnings expectations and the quantity of Fed rate hikes.

Which, of course, likely means the helium begins to leak from Wall Street's overinflated balloon. (The caveat here is Trump's pending tax reform. Lower corporate taxes would give a boost to those who rationalize extreme stock-market valuations because of corporate profit growth. Of course, the chances the Trump's debt-bloating agenda survives Congress is fairly slim, and the chance that corporate profit margins survive at historically excessive rates is equally slim, but more on that in an upcoming post.)

Our Safe-Strategy Play

No one can say what direction stocks will go ultimately. Maybe stocks do find a finger perch higher up this mountain. Or, maybe, the side of the mountain breaks away and it's a helluva fall from here.

Whatever the case, the clear message is that in a risk-reward analysis, stock-market investors face far-greater risk today than reward. The safe strategy at this point is two-fold:

  1. Go through every stock in your portfolio and determine a price that would make you feel sick to your stomach, and then set a stop-loss somewhere north of that amount, at a level you can live with. Increase your exposure to the euro and European stocks (as I explain here).
  2. For the first time in nearly a decade, euro interest rates will be converging on dollar rates. At the same time, because Europe is improving economically, European stocks offer greater value today than do excessively valued U.S. shares. As I've recommended, I'd own the Guggenheim CurrencyShares Euro Trust (NYSEARCA:FXE) for euro exposure, and the iShares MSCI Europe Small-Cap ETF (NASDAQ:IEUS), which will benefit from the early rate-hike cycle coming to Europe.

At this point in the U.S. economy, chances are good that the consumer is reaching the tap-out point. They simply cannot keep borrowing more and more and more money to live their lives. And chances are good that the Fed knows this, and, as such, is in no rush to raise rates.

And that's a message that will have Wall Street removing its rose-colored glasses to see the world as it really is.

Supporting Documents

  1. 170420_Consumer_canary_CHARTS.docx.xlsx

Disclosure: I/we 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.