It's time to consider selling Consumer Discretionary stocks. Photo: Adobe stock

A surprise slump in the University of Michigan’s Consumer Confidence Index for August points to potential weakness in the US economy’s main prop. Consumer spending added 4.7 percentage points to US second-quarter GDP growth, while slumping investment and other factors knocked the overall growth rate to just 2%.

If the consumer weakens, GDP growth could fall below zero. US consumers appear spooked by tariffs even before the Trump Administration’s new and higher tariffs kick in during the remainder of the year. This and other evidence suggests that American consumers are extremely sensitive to price increases, and that consumer spending is vulnerable to a reversal.

I recommend selling more exposed Consumer Discretionary stocks (for example by shorting XLP, the consumer discretionary ETF) against more defensive Consumer Staples stocks (the ETF ticker is XLP). The Consumer Discretionary ETF contains big retailers, hotel chains, automakers, chain restaurants and appliance manufacturers.

Remarkably, the University of Michigan concludes, “The recent decline is due to negative references to tariffs, which were spontaneously mentioned by one-in-three consumers. Unlike concerns about the fiscal cliff, which were promptly resolved, Trump’s tariff policies have been subject to repeated reversals amid threats of higher future tariffs. Such tactics may have some merit in negotiations with China, but they act to increase uncertainty and diminish consumer spending at home. Unlike the repeated tariff reversals, negative trends in consumer sentiment cannot be easily reversed. The data indicate that the erosion of consumer confidence due to tariff policies is now well underway,” the university said in an Aug. 30 press release.

“Compared with those who did not reference tariffs, consumers who made spontaneous negative references to tariffs also voiced higher year-ahead inflation expectations, more frequently expected rising unemployment, and expected smaller annual gains in household incomes,” the commentary added.

The University of Michigan Survey, to be sure, is “soft data,” that is, a sentiment indicator. But there is considerable evidence from hard data that consumer decisions are swayed by relatively small price swings.

Most of the past year’s variation in retail sales, for example, can be explained by changes in the gasoline price. As gas prices rose consumers cut back on retail spending, and vice-versa. Shown below is the year-over-year change in same-store sales as reported by Johnson Redbook compared to the price of gasoline.

If relatively modest changes in the price of gasoline have such a big influence on retail sales, we should expect even more consumer pushback against. price increases due to tariffs.

That has Federal Reserve officials worried. New York Federal Reserve Bank president John Williams said Wednesday, “The consumer is now carrying all of the weight, or much of the weight, for growth going forward,” Bloomberg News reported.  “One thing, though, about consumer spending that you have to be careful about is it’s not really a leading indicator.” Dallas Federal Reserve president Robert Kaplan meanwhile said in Toronto that he was worried that weak manufacturing and investment might spill over into consumer sentiment. If the Federal Reserve waits for consumers to pull back before taking action, Kaplan explained, it will be too late.

Economic weakness puts Trump in a difficult position. I have warned that Trump’s trade war risks his re-election prospects in 2020, for example here. Trump’s vulnerability on the economy has become a favorite topic of political commentators. Politico.com wrote today, “President Donald Trump is staring down a series of trigger points that will determine whether he enters the 2020 campaign backed by his most valuable asset — a healthy U.S. economy — or empty-handed and further on the defensive.”

As the University of Michigan commentary emphasized, one consumer sentiment sours it can’t be easily reversed.  The better part of valor is to stick with US companies that make items that consumers will continue to buy (laundry detergent, soft drinks and so forth) even while they cut back on restaurant meals and new appliance purchases.

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