Inflation Takes Its Toll on American Consumers—Investors Are Next

Inflation is already taking its toll on American consumers, according to a University of Michigan report released on Friday. Investors will be next as evidenced by the action on Wall Street anytime inflation numbers are released by government agencies.

The University of Michigan consumer sentiment, a measure of American consumers' current and future economic conditions, dropped to 61.7 in February 2022, from 67.5 in January. That's well below market forecasts and the lowest in the last decade.

The report comes a day after the U.S. Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI)—a measure of the cost of living—rose at an annual rate of 7.5% in January, up from 7% in the previous month. That was the highest rise in the last 40 years.

"Sentiment continued its downward descent, reaching its worst level in a decade, falling a stunning 8.2% from last month and 19.7% from last February," said the University of Michigan report. “The recent declines have been driven by weakening personal financial prospects, largely due to rising inflation, less confidence in the government's economic policies, and the least favorable long-term economic outlook in a decade."

Low consumer sentiment is a predictor of lower consumer spending down the road. And that's bad news for the U.S. economy and equities. It leads to slower economic growth for the U.S. economy, as consumer spending accounts for close to two-thirds of the U.S. economy. It's also bad news for the global economy as America is its largest economy.

Meanwhile, slower economic growth is bad news for publicly traded companies that sell economically sensitive products to consumers, like furniture, home appliances, and automobiles. Lower consumer spending will strike these companies right at the top line and eventually at the bottom line, driving equity prices lower.

In short, a combination of high inflation and slow growth isn't good for equities, and it could set up Wall Street for a vicious cycle. Lower equity prices could depress further consumer sentiment, something already in play in the February consumer sentiment report.

"The impact of higher inflation on personal finances was spontaneously cited by one-third of all consumers, with nearly half of all consumers expecting declines in their inflation adjusted incomes during the year ahead," added the Michigan University report. "In addition, fewer households cited rising net household wealth since the pandemic low in May 2020, largely due to the falling likelihood of stock price increases in 2022."

Investors in stocks have seen substantial gains in recent years, even during the pandemic, thanks to unprecedented monetary easing by the nation's central bank and fiscal stimulus from Washington, which kept the U.S. economy going.

Unfortunately, some of these policies continue today, and that's a policy mistake, according to Nancy Tengler, CEO and Chief Investment Officer of Laffer Tengler Investments. "We have seen policy mistakes aplenty and, still, the resilient U.S. economy has hummed along," said Tengler. "But beware inflation which can erode nominal growth in a hurry."

And crash U.S. equities, depressing further consumer spending and pushing the U.S. economy into another recession.