The Sentiment Conundrum

Okay, class, what have you learned from my years of teaching and lecturing around our industry about sentiment? That’s right: sentiment is self-fulfilling.

It is remarkably interesting to watch what has occurred since March, when inflation continued to be reported as being stubbornly persistent, and the Fed, like me, changed their view that the rise in prices was not transient as a result of the artificial economic moves that stoked inflation.

This changed view has resulted in a series of interest rate hikes that has had its effect, and has caused consumer sentiment to plunge. Moves such as the huge stimulus injected into the economy that put so much money into the pockets of consumers only hastened the potential for a recession, and the Fed reaction of raising interest rates just deferred the possibility of a downturn further out on the calendar.

To be sure, by some accounts, one of the standard measures of two quarters of contraction in gross domestic product has become a reality, and technically we are in a mild recession since the economy contracted 1.6 percent in the first quarter, followed by 0.9 percent in the second.

But what causes recessions? They occur when a chain of events picks up momentum and does not stop until the economy shrinks. Each event is connected to something that happened before and something that will happen in the future. If the price of a hamburger goes up, you might stop buying hamburgers. This would impact a restaurant, and that would impact a server. There are many interconnected chains like this throughout the economy.

As I have said so many times, the poster child for inflation is the big, black digital numbers on the gas pump. Along with the supermarket bill at checkout, it is the two givens in our family budget that we cannot control, and both have been pressured to the highest levels of inflation in over 40 years.

This had the effect of causing consumer sentiment to tumble in a remarkably brief period of time: from 99.8 in January to 71.8 in April; then when the interest rate hikes started to occur, the stock market fell rapidly, and sentiment plunged further to 50.0 in June, but saw a slight uptick to 51.5 in July.

Why the uptick? Look at the poster child: gas prices are moderating.

Having said that, those who monitor consumer sentiment, the engine that drives 70 percent of our total GDP, have never witnessed such a precipitous drop in such a brief period of time, and this has the effect of souring consumers on the current political and economic climate. And the only way to allow consumers to turn their views to positive is for prices to moderate, and for gas prices to come down.

And today, companies and consumers are both nervous about the future. Economic anxiety can make people decide to hold on to their money and stop spending. These kinds of decisions can help lower inflation, but that can only happen over time. It’s possible the Fed could play things perfectly and stop a deep recession before one begins. They could end up slowing the economy without causing it to contract altogether. In this case, companies don’t end up laying workers off, inflation comes down, and people feel more assured about the economy.

So where does the economy go from here? Only time will tell if the Fed can get inflation under control and stabilize the economy. The central bank is on a path to significantly raise rates this year, and there are signs that those moves are already working. The housing market is cooling off but not crashing. And pockets of the labor market are slowing despite unemployment at a strong 3.6 percent.

But it all comes down to sentiment. Only when the consumer sees inflation—and the crushing effect it has on the American pocketbook— as being in the rear view mirror will sentiment grow positively, and have a correspondingly positive impact on our economy.

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.