Sentiment Sours As Price Pressure Persists

With noisy weakness is not fading, the opportunity cost of stubborn exposure to US equities is rising

The University of Michigan Consumer Sentiment Index for March plummeted to one of its lowest levels ever. While extremely sour sentiment can lead to big bounces for stocks, this usually occurs after investors have already re-positioned away from equities. We will get an asset allocation positioning update from the AAII this week, but at this point equity exposure remains historically elevated.

Data from the Federal Reserve shows that household exposure to equities (relative to non-equity financial assets) is near an all-time high. There is a strong inverse relationship between equity exposure and forward stock market returns. There is plenty of room for equity exposure to unwind and the current starting point suggests an unfavorable backdrop for US equities in the years ahead.

Fueling the decline in consumer sentiment has been a surge in inflation expectations. The final readings from the March Consumer Sentiment report show year-ahead inflation expectations approaching their post-COVID highs, while longer-term inflation expectations have spiked to the highest level since the early 1990’s.

Concerns about higher inflation may not be unfounded. Median PCE inflation continues to run hotter than prior to COVID and it is well-above the Fed’s 2% target. Moreover, inflation is re-accelerating. For headline, core and median PCE inflation, the 3-month change is above the 6-month change, which is above the 12-month change. The Fed is losing ground on its fight against inflation while the outlook for economic growth is deteriorating.

Market Insights: A deteriorating macro backdrop and elevated policy uncertainty has contributed to a marked decline in risk appetite in Q1. Similar declines in risk appetite in 2022 and 2018 led to peak-to-trough declines in the S&P 500 of 25% and 18%, respectively.