Market Bulls Face a Test When Consumers Begin to Show Signs of Stress

As speculation grows regarding the timing of the Federal Reserve's potential reduction of interest rates from a 23-year peak, indications of strain among consumers are surfacing, which, if prolonged, could signify trouble for the stock market.

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Entering 2024, investors anticipated approximately six decreases in interest rates of a quarter percentage point each, starting as early as March. However, persistent inflation figures, a tight labor market, and other economic indicators prompted investors to significantly revise down these expectations. Presently, investors are forecasting only two to three rate cuts, slated to commence in the autumn.

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Despite a decline in stock prices observed in April, investors have predominantly accepted this shift with equanimity. They remain optimistic, under the belief that a robust economy, coupled with resilient consumer activity, will sustain profit growth. Nevertheless, consumers are exhibiting heightened discretion in their spending habits. Several major companies, including McDonald’s, Shake Shack, Wendy’s, Starbucks, and Yum Brands, reported lackluster sales growth in the first quarter of the year.

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Concurrently, recent data indicates that while consumers' incomes and expenditures continue to increase, their spending is surpassing their income, suggesting heightened financial strain. Mace McCain, Chief Investment Officer at Frost Investment Advisors, highlights the potential impact of rising unemployment and job insecurity on consumer behavior. He emphasizes the importance of monitoring job statistics to gauge when consumer stress will translate into reduced spending, potentially slowing down the economy.

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Data released last Friday revealed weaker-than-anticipated job growth in the United States for April. The economy added only 175,000 new jobs, marking a six-month low and falling short of economists' projections of a 240,000 increase. The unemployment rate also rose marginally to 3.9% from 3.8%, maintaining its streak of staying below 4% for 27 consecutive months.

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Despite these developments, there was no widespread panic. Instead, stocks surged as investors envisioned an ideal scenario—neither too hot nor too cold—for the economy, which would be conducive to Federal Reserve policymakers.

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Gregory Daco, Chief Economist at EY, described the data as "encouraging," noting a balanced labor market with moderated labor demand, historically low employment rates, and a cooling trend in wage growth, all of which align with the Fed's objectives.

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McCain adds that the jobs report corroborates evidence of modest labor market weakness and slower growth, potentially paving the way for the Fed to proceed with rate cuts.

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