Understanding the Disconnect Between Consumers and the Stock Market
Connect with us

Markets

Understanding the Disconnect Between Consumers and the Stock Market

Published

on

Understanding the Disconnect Between Consumers and the Stock Market

Can I share this graphic?
Yes. Visualizations are free to share and post in their original form across the web—even for publishers. Please link back to this page and attribute Visual Capitalist.
When do I need a license?
Licenses are required for some commercial uses, translations, or layout modifications. You can even whitelabel our visualizations. Explore your options.
Interested in this piece?
Click here to license this visualization.

The Disconnect Between Consumers and Stock Markets

Consumer sentiment indices are relatively accurate indicators for the outlook of an economy. They rise during periods of growth as consumers become more financially confident, and fall during recessions as consumers cut back on discretionary spending.

Since the direction of the overall economy also affects stock markets, measures of consumer sentiment have historically moved in tandem with major indices like the S&P 500. Since the COVID-19 pandemic began, however, consumers and stock markets have become noticeably disjointed from one another.

To help us understand why this may be the case, this infographic charts the University of Michigan’s Index of Consumer Sentiment against the S&P 500, before diving into potential underlying factors for their divergence.

A Tale of Two Indices

Before we compare these two indices, it’s helpful to first understand how they’re comprised.

The Index of Consumer Sentiment

The University of Michigan’s Index of Consumer Sentiment (ICS) is derived from a monthly survey of consumers that aims to get a snapshot of personal finances, business conditions, and buying conditions in the market.

The survey consists of five questions (paraphrased):

  • Are you better or worse off financially compared to a year ago?
  • Will you be better or worse off financially a year in the future?
  • Will business conditions during the next year be good, bad, or other?
  • Will business conditions over the next five years be good, bad, or other?
  • Is it a good time to make large purchases such as major household appliances?

A score for each of these questions is calculated based on the percent of favorable and nonfavorable replies. The scores are then aggregated to arrive at the final index value, relative to 6.8—the 1966 base period value.

The S&P 500

The S&P 500 is a market capitalization-weighted index of the 500 largest publicly traded U.S. companies. A company’s market capitalization is calculated as its current stock price multiplied by its total number of outstanding shares.

Market caps change over time, with movements determined by daily stock price fluctuations, the issuance of new stock, or the repurchase of existing shares (also known as share buybacks).

The COVID-19 Divergence

Throughout past market cycles, these two indices have displayed some degree of correlation.

During the bull market of the ‘90s, the S&P 500 generated an astonishing 417% return, and was accompanied by a 75% increase in consumer sentiment. Critically, both indices also peaked at roughly the same time. The ICS began to decline after reaching its record high of 112.0 in January 2000, while the S&P 500 began to falter in August that same year.

Fast forwarding to 2020, we can see that these indices have responded quite differently during the pandemic so far:

IndexJan 2020 Feb 2020 Mar 2020 Apr 2020 May 2020 June 2020 July 17, 2020 
ICS Value99.810189.171.872.378.173.2
ICS YTD0.5%1.7%-10.3%-27.7%-27.2%-21.4%-26.3%
S&P 500 Value3225.52954.22584.62912.43044.33100.33224.7
S&P 500 YTD-0.2%-8.6%-20.0%-9.9%-5.8%-4.0%-0.2%

All figures as of month end unless otherwise specified. Source: Yahoo Finance

The ICS has not yet recovered from its initial decline beginning in March, whereas the S&P 500 has seemingly bounced back during the same time frame.

Examining the Disconnect

Why are stock markets failing to recognize the hardships that consumers are feeling? Let’s examine two central factors behind this disconnect.

Reason 1: Tech’s Dominance of the S&P 500

Recall that a company’s weight in the S&P 500 is determined by its market cap. This means that certain sectors can form a larger part of the index than others. Here’s how each sector sizes up:

S&P 500 SectorIndex weight as of June 30, 2020 (%)
Information technology 27.5%
Health care14.6%
Consumer discretionary10.8%
Communication services10.8% 
Financials10.1%
Industrials8.0%
Consumer staples7.0%
Utilities3.1%
Real estate2.8%
Energy2.8%
Materials2.5%

Source: S&P Global

Based on this breakdown, we can see that the information technology (IT) sector accounts for over a quarter of the S&P 500. With a weighting of 27.5%, the sector alone is bigger than the bottom six combined (Industrials to Materials).

This inequality means the performance of the IT sector has a stronger relative impact on the index’s overall returns. Within IT, we can highlight the FAANGM subset of stocks, which include some of America’s biggest names in tech:

StockMarket Cap as of June 30, 2020 ($)
Apple$1.6 trillion
Microsoft$1.5 trillion
Amazon$1.4 trillion
Google$930 billion
Facebook$668 billion
Netflix$200 billion
S&P 500 average$53 billion

Source: Yahoo Finance

These companies have grown rapidly over the past decade, and continue to perform strongly during the pandemic. If this trend continues, the S&P 500 could skew even further towards the IT sector, and become less representative of America’s overall economy.

Reason 2: The U.S. Federal Reserve

Stock prices typically reflect a company’s future earnings prospects, meaning they are influenced, to a degree, by the outlook for the broader economy.

With an ongoing pandemic and steep decline in consumer sentiment, it’s reasonable to believe that many company prospects would look bleak. This is especially true for consumer cyclicals—companies like automobile manufacturers that rely on discretionary spending.

In a somewhat controversial move, the U.S. Federal Reserve has stepped in to counter these effects by creating the Secondary Market Corporate Credit Facility (SMCCF). This facility operates two programs which ensure businesses have access to funding during the pandemic.

Corporate Bond Purchase Program
The SMCCF is currently buying corporate bonds from an index of nearly 800 companies. Of the ten largest recipients of this program, five are categorized as consumer cyclical:

IssuerCategoryIndex Weight (%)
Toyota Motor Credit CorpConsumer cyclical1.74%
Volkswagen Group AmericaConsumer cyclical1.74%
Daimler Finance NA LLCConsumer cyclical1.72%
AT&T IncCommunications1.60%
Apple IncTechnology1.60%
Verizon CommunicationsCommunications1.60%
General ElectricCapital goods1.48%
Ford Motor Credit Co LLCConsumer cyclical1.34%
Comcast CorpCommunications1.32%
BMW US Capital LLCConsumer cyclical1.25%

Source: Investopedia

This program is intended to support the flow of credit, but its announcement in June also gave stock markets a boost in confidence. With the Fed directly supporting corporations, shareholders are being shielded from risks related to declining sales and bankruptcy.

By the end of June, the SMCCF had purchased $429 million in corporate bonds.

ETF Purchase Program
The SMCCF is also authorized to purchase corporate bond ETFs, a historic first for the Fed. The facility’s five largest ETF purchases as of June 18, 2020, are detailed below:

ETF Name Purchase size ($)ETF Description
iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)$1.7 billionTracks an index composed of USD-denominated, investment grade corporate bonds.
Vanguard Short-Term Corporate Bond ETF (VCSH)$1.3 billionInvests primarily in investment grade corporate bonds, maintaining an average maturity of 1 to 5 years.
Vanguard Intermediate-Term Corporate Bond ETF (VCIT)$1.0 billionInvests primarily in investment grade corporate bonds, maintaining an average maturity of 5 to 10 years.
iShares Short-Term Corporate Bond ETF (IGSB)$608 millionTracks an index composed of USD-denominated investment-grade corporate bonds with maturities between 1 and 5 years.
SPDR Barclays High Yield Bond ETF (JNK)$412 millionSeeks to provide a diversified exposure to USD-denominated high yield corporate bonds.

Source: Investopedia

Although the SMCCF’s purchase of ETFs outsize those of corporate bonds, the Fed has signaled its intention to make direct bond purchases its primary focus going forward.

Will Markets and Consumers Reconnect Anytime Soon?

It’s hard to see the S&P 500 moving towards a more balanced sector composition in the near future. America’s big tech stocks have been resilient during the pandemic, with some even reaching new highs.

The Fed also remains committed to providing corporations with credit, thereby enabling them to “borrow” their way out of the pandemic. These commitments have propped up stock markets by reducing bankruptcy risk and potentially speeding up the economic recovery.

Consumer sentiment, on the other hand, has yet to show signs of recovery. Surveys released in early July may shed some light on why—63% of Americans believe it will take a year or more for the economy to fully recover, while 82% are hoping for an extension of COVID-19 relief programs.

With both sides moving in opposite directions, it’s possible the disconnect could grow even larger before it starts to shrink.

Support the Future of Data Storytelling

Sorry to interrupt your reading, but we have a favor to ask. At Visual Capitalist we believe in a world where data can be understood by everyone. That’s why we want to build the VC App - the first app of its kind combining verifiable and transparent data with beautiful, memorable visuals. All available for free.

As a small, independent media company we don’t have the expertise in-house or the funds to build an app like this. So we’re asking our community to help us raise funds on Kickstarter.

If you believe in data-driven storytelling, join the movement and back us on Kickstarter!

Thank you.

Support the future of data storytelling, back us on Kickstarter
Click for Comments

Markets

Interest Rate Hikes vs. Inflation Rate, by Country

Inflation rates are reaching multi-decade highs in some countries. How aggressive have central banks been with interest rate hikes?

Published

on

Interest Rate Hikes vs. Inflation Rate, by Country

Imagine today’s high inflation like a car speeding down a hill. In order to slow it down, you need to hit the brakes. In this case, the “brakes” are interest rate hikes intended to slow spending. However, some central banks are hitting the brakes faster than others.

This graphic uses data from central banks and government websites to show how policy interest rates and inflation rates have changed since the start of the year. It was inspired by a chart created by Macrobond.

How Do Interest Rate Hikes Combat Inflation?

To understand how interest rates influence inflation, we need to understand how inflation works. Inflation is the result of too much money chasing too few goods. Over the last several months, this has occurred amid a surge in demand and supply chain disruptions worsened by Russia’s invasion of Ukraine.

In an effort to combat inflation, central banks will raise their policy rate. This is the rate they charge commercial banks for loans or pay commercial banks for deposits. Commercial banks pass on a portion of these higher rates to their customers, which reduces the purchasing power of businesses and consumers. For example, it becomes more expensive to borrow money for a house or car.

Ultimately, interest rate hikes act to slow spending and encourage saving. This motivates companies to increase prices at a slower rate, or lower prices, to stimulate demand.

Rising Interest Rates and Inflation

With inflation rates hitting multi-decade highs in some countries, many central banks have announced interest rate hikes. Below, we show how the inflation rate and policy interest rate have changed for select countries and regions since January 2022. The jurisdictions are ordered from highest to lowest current inflation rate.

JurisdictionJan 2022 InflationMay 2022 InflationJan 2022 Policy RateJun 2022 Policy Rate
UK5.50%9.10%0.25%1.25%
U.S.7.50%8.60%0.00%-0.25%1.50%-1.75%
Euro Area5.10%8.10%0.00%0.00%
Canada5.10%7.70%0.25%1.50%
Sweden3.90%7.20%0.00%0.25%
New Zealand5.90%6.90%0.75%2.00%
Norway3.20%5.70%0.50%1.25%
Australia3.50%5.10%0.10%0.85%
Switzerland1.60%2.90%-0.75%-0.25%
Japan0.50%2.50%-0.10%-0.10%

The Euro area has 3 policy rates; the data above represents the main refinancing operations rate. Inflation data is as of May 2022 except for New Zealand and Australia, where the latest quarterly data is as of March 2022.

The U.S. Federal Reserve has been the most aggressive with its interest rate hikes. It has raised its policy rate by 1.5% since January, with half of that increase occurring at the June 2022 meeting. Jerome Powell, the Federal Reserve chair, said the committee would like to “do a little more front-end loading” to bring policy rates to normal levels. The action comes as the U.S. faces its highest inflation rate in 40 years.

On the other hand, the European Union is experiencing inflation of 8.1% but has not yet raised its policy rate. The European Central Bank has, however, provided clear forward guidance. It intends to raise rates by 0.25% in July, by a possibly larger increment in September, and with gradual but sustained increases thereafter. Clear forward guidance is intended to help people make spending and investment decisions, and avoid surprises that could disrupt markets.

Pacing Interest Rate Hikes

Raising interest rates is a fine balancing act. If central banks raise rates too quickly, it’s like slamming the brakes on that car speeding downhill: the economy could come to a standstill. This occurred in the U.S. in the 1980’s when the Federal Reserve, led by Chair Paul Volcker, raised the policy rate to 20%. The economy went into a recession, though the aggressive monetary policy did eventually tame double digit inflation.

However, if rates are raised too slowly, inflation could gather enough momentum that it becomes difficult to stop. The longer high price increases linger, the more future inflation expectations build. This can result in people buying more in anticipation of prices rising further, perpetuating high demand.

“There’s always a risk of going too far or not going far enough, and it’s going to be a very difficult judgment to make.” — Jerome Powell, U.S. Federal Reserve Chair

It’s worth noting that while central banks can influence demand through policy rates, this is only one side of the equation. Inflation is also being caused by supply chain issues, a problem that is more or less outside of the control of central banks.

Continue Reading

Markets

3 Insights From the FED’s Latest Economic Snapshot

Stay up to date on the U.S. economy with this infographic summarizing the most recent Federal Reserve data released.

Published

on

us economic snapshot

3 Insights From the Latest U.S. Economic Data

Each month, the Federal Reserve Bank of New York publishes monthly economic snapshots.

To make this report accessible to a wider audience, we’ve identified the three most important takeaways from the report and compiled them into one infographic.

1. Growth figures in Q2 will make or break a recession

Generally speaking, a recession begins when an economy exhibits two consecutive quarters of negative GDP growth. Because U.S. GDP shrank by -1.5% in Q1 2022 (January to March), a lot rests on the Q2 figure (April to June) which should be released on July 28th.

Referencing strong business activity and continued growth in consumer spending, economists predict that U.S. GDP will grow by +2.1% in Q2. This would mark a decisive reversal from Q1, and put an end to recessionary fears for the time being.

Unfortunately, inflation is the top financial concern for Americans, and this is dampening consumer confidence. Shown below, the consumer confidence index reflects the public’s short-term outlook for income, business, and labor conditions.

consumer price index 2005 to 2022

Falling consumer confidence suggests that more people will delay big purchases such as cars, major appliances, and vacations.

2. The COVID-era housing boom could be over

Housing markets have been riding high since the beginning of the COVID-19 pandemic, but this run is likely coming to an end. Here’s a summary of what’s happened since 2020:

  • Lockdowns in early 2020 created lots of pent-up demand for homes
  • Greater household savings and record-low mortgage rates pushed demand even further
  • Supply chain disruptions greatly increased the cost of materials like lumber
  • Construction of new homes couldn’t keep up, and housing supply fell to historic lows

Today, home prices are at record highs and the cost of borrowing is rapidly rising. For evidence, look no further than the 30-year fixed mortgage rate, which has doubled to more than 6% since the beginning of 2022.

Given these developments, the drop in the number of home sales could be a sign that many Americans are being priced out of the market.

3. Don’t expect groceries to become any cheaper

Inflation has been a hot topic this year, especially with gas prices reaching $5 a gallon. But there’s one category of goods that’s perhaps even more alarming: food.

The following table includes food inflation over the past three years, as the percent change over the past 12 months.

DateCPI Food Component (%)
2018-02-011.4%
2019-05-012.0%
2019-06-011.9%
2019-07-011.8%
2019-08-011.7%
2019-09-011.8%
2019-10-012.1%
2019-11-012.0%
2019-12-011.8%
2020-01-011.8%
2020-02-011.8%
2020-03-011.9%
2020-04-013.5%
2020-05-014.0%
2020-06-014.5%
2020-07-014.1%
2020-08-014.1%
2020-09-014.0%
2020-10-013.9%
2020-11-013.7%
2020-12-013.9%
2021-01-013.8%
2021-02-013.6%
2021-03-013.5%
2021-04-012.4%
2021-05-012.1%
2021-06-012.4%
2021-07-013.4%
2021-08-013.7%
2021-09-014.6%
2021-10-015.3%
2021-11-016.1%
2021-12-016.3%
2022-01-017.0%
2022-02-017.9%
2022-03-018.8%
2022-04-019.4%
2022-05-0110.1%

From this data, we can see that food inflation really picked up speed in April 2020, jumping to +3.5% from +1.9% in the previous month. This was due to supply chain disruptions and a sudden rebound in global demand.

Fast forward to today, and food inflation is running rampant at 10.1%. A contributing factor is the impending fertilizer shortage, which stems from the Ukraine war. As it turns out, Russia is not only a massive exporter of oil, but wheat and fertilizer as well.

Continue Reading

Subscribe

Popular