Average U.S. home prices have sunk to 2002 levels, while average U.S. gasoline prices remain above $3.80 per gallon. Not surprisingly, the Conference Board index of consumer confidence reached a six-month low in May, and U.S. consumer spending barely grew after accounting for inflation in April and May.
Yet the two most widely quoted U.S. stock indexes, the Dow Industrials and S&P 500 Index, are within 4% of three-year highs. Consensus expectations for year-ahead S&P 500 earnings have reached record levels, reflecting increases every month this year.
More than a few commentators have noted the seeming contradiction between the average U.S. consumer and the major U.S. stock averages, but we see several reasons for these averages to chart increasingly divergent paths:
• U.S. government figures show consumer spending (including personal and government outlays on health care) is equal to about two-thirds of gross domestic product. But foreign operations generate an estimated one-fourth of S&P 500 profits. For the roughly 250 companies in the S&P 500 that break out sales by region, nearly half of sales come from outside the U.S.
• Many of the sectors leading the U.S. stock market do not hinge on the U.S. consumer. Among sectors that have outperformed the S&P 500 Index on a year-to-date basis, consumer staples (11% of the S&P 500's market value), energy (13%), health care (12%), industrials (11%), and utilities (3%) do not depend much on discretionary consumer purchases.
• Spending is increasingly dominated by high earners, with the top 20% accounting for an estimated 40% of U.S. consumer spending. Indeed, it's worth noting that the S&P 500 consumer discretionary sector (11%) has outperformed so far this year.
• For U.S. equity investors, things are pretty good right now. Yields on 10-year Treasury bonds are back below 3%, and today's sluggish economic numbers are widely expected to keep the Federal Reserve's target for overnight interest rates near 0% until the second half of 2012 at the earliest. The median S&P 500 company delivered 14.6% year-to-year profit growth in the most recent quarter, a growth rate higher than 94% of the month-end observations since 1990. Median sales growth is 9.3%, higher than 74% of monthly observations.
The bears are right to worry about the plight of the average U.S. consumer, but investors should not expect U.S. stocks to move with the consumer outlook on a month-to-month or even year-to-year basis. For now, we're holding 12% to 13.5% of our buy lists in a short-term bond fund.