The silent engine of the share market

The health of the consumer is “arguably the single most important factor driving equity market performance in developed economies today,” says Ross Cartwright, lead strategist in the Strategy and Insights Group at MFS, in a recent paper by the firm.

“From retail giants like Walmart and Amazon to tech innovators like Apple and Tesla, consumer spending directly impacts corporate earnings, sector performance and overall market sentiment. For sophisticated investors, understanding the consumer’s role is essential – not just for identifying risks, but also for uncovering opportunities in an evolving economic landscape.”

For every individual listed company, share prices are driven by earnings growth, and price/earnings (P/E) ratio expansion. Every company is selling goods or services, either to consumers or to other companies. Ultimately, for equity market indices, that makes the consumer the driving force.

Of course, for every individual listed company, there will always be idiosyncratic influences affecting the share price – good or bad. But overall, the economy drives the sharemarket, and consumers drive the economy. Which is why understanding the health of the consumer matters more than ever, says MFS.

In the US, personal consumption constitutes more than two-thirds of gross domestic product (GDP), at 68 per cent, making it the lifeblood of the economy. And with the US accounting for 70 per cent of the MSCI World Index, the health of US consumers has global consequences for equity markets. While other developed economies like Europe and Japan may rely more heavily on industrial production or trade, consumption remains comfortably more than half of economic activity.

Consumer spending drives corporate revenues, says Cartwright. “Consumer-facing companies, particularly in discretionary sectors, are directly impacted by changes in spending patterns. A slowdown in spending disproportionately affects cyclical exposures – new cars, patio furniture, travel and leisure or other ‘nice-to-have’ items – while staples or essentials have typically held up better and outperformed these other sectors.

Lower consumer spending can trigger ripple effects across industries, from manufacturers to transport companies, and even lead to cuts in advertising budgets, compounding the pressure on revenues across the market.

In the US, consumers have shown remarkable “resilience amid complexity,” says MFS, supported by a robust job market, healthy household balance sheets and favourable debt positions. Fiscal stimulus continues to support corporate margins, reducing the likelihood of lay-offs – a key factor in sustaining consumer spending. The US consumer is not an homogeneous group; approximately 40 per cent of consumption is driven by the top 25 per cent of wage-earners, who remain healthy. 

However, there are emerging signs of pressure, says Cartwright. “Higher interest rates are starting to erode disposable income for lower-income cohorts reliant on credit cards and personal loans. Additionally, house prices may be beginning to soften in certain regions, which could weigh on consumer confidence. At the same time, however, lower energy prices provide a reprieve for households, while ongoing fiscal stimulus indirectly supports consumer spending by maintaining corporate profitability. Profitable companies tend not to lay-off workers.

The current slowdown in immigration may also act as a hidden support for real wage growth, he says, keeping the US consumer in relatively good shape despite near-term challenges.

In Europe, there is an ongoing consumer recovery. European consumers have faced stagnant economic growth, inflationary pressures and an energy crisis, exacerbated by the abrupt halt of Russian gas supplies after the invasion of Ukraine. Unlike the US, Europeans are more sensitive to interest rate changes because they don’t have access to long-dated fixed-rate mortgages. 

“Despite these challenges, improving house prices, strong equity markets, stronger loan growth and recovering consumer confidence could see European consumers surprise on the upside, offering a potential catalyst for non-US equity markets,” says Cartwright.

In Japan, the nation is at a turning point. Japan’s stock of savings is high, but savings rates remain low. Low Japanese savings rates have been a function of an ageing population, shrinking labour force and stagnant real wage growth for many years. Despite soft real wage data, the job market remains tight, and the spring Shuntõ (literally, “spring wage offensive,” referring to the annual wage negotiations between enterprise unions and employers) wage negotiations have seen large Japanese companies raise wages by more than 5.25 per cent this year – the largest increase in 34 years. The result of this has been a recent uptick in savings.

Inflation has picked up over the last year, and though rising, wages remain negative in real terms despite the Japanese government seeking 1 per cent annual real wage growth to drive consumption and boost economic growth. Ongoing labour shortages are likely to keep upward pressure on wages, which is positive for consumption. However, the increasingly ageing population continues to be a drag on consumption growth. Since the Fukushima nuclear disaster in 2011, Japan has become increasingly reliant on imported energy and while it remains susceptible to energy shocks, low energy prices are currently working in Japan’s favour. (In February, the Japanese cabinet approved a new Basic Energy Plan that removed previous commitments to “minimise reliance on nuclear energy.” The new plan calls for increasing nuclear’s share from 8.5 per cent today to 20 per cent by 2040, alongside more renewable energy.)

In Australia, where consumer spending represents almost 52 per cent of GDP, perhaps the foremost gauge of the health of the consumer is the Westpac–Melbourne Institute Consumer Sentiment Index, which has been published every quarter since 1974. The index rose 3.1 per cent points between April and July, but at 93.1 remains below the recent high in March and in pessimistic territory overall (readings below 100 indicate pessimism, while those above 100 suggest optimism).

Australian consumer sentiment has “clawed back about half of the shock from the ‘liberation day’ tariff announcements in April,” says Matthew Hassan, head of Australian macro-forecasting at Westpac. “Detail suggests the RBA’s surprise move to leave rates on hold at its last meeting ‘checked’ what would probably have been a more substantive rise in July.

Concomitantly, risk aversion remains very high. The Westpac Risk Aversion Index ticked down up from 45.4 in March, just prior to the ‘liberation day’ tariff announcements, to 49.0 in June. This compares to a long run average of 18.

The sentiment mix suggests demand is likely to remain relatively weak near term, says Hassan. CSI±, a modified indicator that correlates well with per capita spending, posted a solid rebound from a tariff-related fall in April, but at 82.3 is still essentially unchanged since late last year, and well below the long-run average of 100. “The latest reading is broadly consistent with a continuation of the modest declines in per capita spend seen over the past year,” says Hassan.

Despite an ‘on again, off again’ rate cut prospect in July, consumers are becoming even more confident that interest rates are heading lower. The Westpac-Melbourne Institute Mortgage Rate Expectations Index dropped 15 per cent over the last three months, to a 13-year low of 83.1.

Consumer expectations for inflation and wages growth continue to hold around benign levels, below longer run averages but slightly above the averages seen in the years prior to COVID. 

Attitudes towards major purchases in Australia are recovering, but still have a long way to go. The ‘time to buy a major item’ index rose 8.4 per cent over the three months to July, briefly nudging into positive territory in June. The index is up nearly 20 per cent on a year ago, but still around the lows seen during COVID and 20 per cent below its long-run average.

Australian retail sales rose 1.2 per cent in June and 0.8 per cent through the second quarter. However, price growth was the primary support for nominal sales during the quarter, with real retail sales rising just 0.3 per cent. The signal from personal credit growth was also promising, suggesting credit card activity may have picked up towards the end of the second quarter. While it remains to be seen if these outcomes are more signal than noise, following such a lengthy period of disappointment, these outcomes are certainly welcome.

Homebuyer sentiment in Australia is thawing slowly. The ‘time to buy a dwelling’ index rose 3.3 per cent over the three months to July but at 88.5 is still firmly pessimistic. There is a slightly better tone amongst consumers in NSW and Vic where homebuyer sentiment is close to ‘neutral’. 

Consumer house price expectations remain strongly positive. The Westpac–Melbourne Institute Consumer House Price Expectations Index rose another 6.1 per cent over the three months to July, briefly touching a 12-year high in June. At 162.8, the index is “unambiguously upbeat,” says Hassan.

General uncertainty about the economic outlook is eating away at confidence around jobs. The Westpac–Melbourne Institute Unemployment Expectations Index deteriorated slightly between April and July, moving back in line with long run averages. Readings are consistent with ‘flat’ labour market conditions rather than more active fears of job loss.

James Dunn

James is an experienced senior journalist and editor of The Inside Network's publications.