Consumer Confidence in Rising Stock Prices

A recent consumer survey conducted by the New York Federal Reserve has revealed some intriguing insights. The survey indicated that the expectation for higher stock prices in the upcoming year has increased from 39% to 41% since the previous month. Interestingly, inflation expectations have seen a slight decrease. Consumer sentiment has shown a clear divide, with certain demographics flourishing while others struggle. However, with the stock market nearing record highs, it's not surprising that stock owners are feeling optimistic.

Increased Exuberance for Stock Prices

The yearly change in consumer surveys regarding higher stock prices has shown a growing enthusiasm among investors. This is in line with the market rally that started in 2022. However, the survey also suggests that this bullish sentiment is reflective of the wealth divide. This is evident when considering the distribution of household equity ownership, with the top 10% of households holding 85% of equities. Despite this, the survey data shows that rising stock market prices have boosted confidence across all age and income groups. This is not surprising considering the constant promotion of the bullish market by both social and mainstream media.

Confidence Among Lower and Middle-Income Brackets

When analyzing the survey data by income bracket, it is clear that the most significant boosts in confidence have been seen among the lowest and middle-income brackets. This is likely due to the popularization of financial markets through trading apps like Robinhood and the increasing influence of social media commentary. As a result, lower-income brackets are joining the fray in hopes of quickly amassing wealth. However, this rising bullish sentiment also carries a warning.

Caution Amidst Bullish Sentiment

To understand the potential issue, we need to consider where capital gains come from. They primarily result from market capitalization, nominal economic growth, and dividend yield. Using a formula, we can calculate returns over the next decade. This calculation assumes a 2% annualized GDP growth, a flat current market cap/GDP, and a 2% dividend yield. The result is a negative forward return. Despite these fundamental factors, retail investors are becoming increasingly reckless. Household equity ownership is nearing record levels, a sign of exuberance that has historically signaled significant market cycle peaks.

Investor Behavior and Future Returns

If economic growth reverses, the impact on valuations could be severe. This has been the case at previous peaks when expectations surpassed economic realities. It's a well-known fact that investors tend to buy the most at the top and the least at the bottom, a clear reflection of investor behavior over time. The average investor allocation to equities has a strong correlation with the S&P 500's future 10-year returns. This suggests that future returns will revert towards zero over the next decade from current levels of household equity allocations by investors.

Reality Check for Exuberance

Currently, equity markets are on the rise, especially with expectations for earnings growth surging. Analysts are predicting nearly 20% annualized growth rates over the next year and a half. Corporations have also been engaging in massive share buyback programs, which have pushed up prices and reported earnings per share. However, as economic growth slows down, profit margins will start to revert, and disinflation will eat into earnings. Profit margins are closely tied to economic activity. When the market trades significantly above actual profits, a mean-reverting event always occurs to align expectations with economic realities.

Risks Ahead

There are many potential pitfalls in the upcoming months and quarters, especially with slowing economic growth and unemployment. While the consumer survey shows a bullish outlook for continued asset price increases, this sentiment is based on the hope that the Federal Reserve has everything under control. However, history suggests that this may not be the case.

Final Thoughts

This article presents an interesting look into the current state of consumer sentiment towards the stock market. It raises questions about the sustainability of the current bullish sentiment and the potential risks that lie ahead. What are your thoughts on this matter? Feel free to share this article with your friends and engage in a discussion. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.