Will Wall Street's rally end if American consumers close their wallets?

US consumer sentiment hits 5-month low at 46.3

Earnings outlook for consumer-facing firms deteriorates

Stock market gains concentrated in AI, big tech

Slowdown in household spending could drag broader market

US President Donald Trump is shown on a broadcast screen at the New York Stock Exchange. [Getty Images]

The purchasing power of American consumers — who kept spending despite high prices and high interest rates, propping up the US economy — is showing signs of strain. Rising energy costs tied to the Iran war and mounting living expenses are rapidly souring consumer sentiment. With US stocks trading near all-time highs, warnings are emerging on Wall Street that a spending slowdown could squeeze corporate earnings and cut short the market's rally.

According to Bloomberg and other outlets, Wall Street's concern over the sustainability of the stock market's advance is growing as US consumers' capacity to spend weakens. Analysts warn that a slowdown in private consumption — which accounts for roughly two-thirds of the US economy — could drag down corporate sales and profits, weighing on the broader market.

The clearest warning signal has come from consumer sentiment. The University of Michigan's preliminary October consumer sentiment index fell to 46.3 from 48.1 in September, its lowest level in five months. Consumers' assessment of current economic conditions also dropped to an all-time low, a decline attributed to high fuel prices and rising costs for food and other essentials.

Anxiety over inflation is also intensifying. Consumers' expected inflation rate over the next year edged up to 4.7 percent in October from 4.6 percent in September, while long-term inflation expectations rose to 3.5 percent from 3.4 percent. If the perception that prices will keep rising becomes more widespread, households may begin cutting back first on discretionary spending such as dining out and clothing.

Warning signs are also appearing in the earnings outlook for consumer-facing companies. According to Bloomberg, the projected earnings growth rate for consumer discretionary and consumer staples sectors within the S&P 500 has turned negative for the first time since late 2024. Even as overall US corporate earnings expectations remain intact, sectors sensitive to consumer spending are underperforming on a relative basis.

Share prices and earnings at major consumer-facing companies — including McDonald's, Nike and Lululemon — have also shown weakness. As consumers squeezed by living costs pull back on dining out and clothing, the growth outlook for those companies is coming under pressure.

Investor sentiment toward consumer-related sectors is also deteriorating. Consumer discretionary ETFs recorded net outflows of $638 million in September. The equal-weighted consumer discretionary index has returned roughly 21 percentage points less than the S&P 500 this year, meaning that outside the strength of a handful of large-cap names, consumer-sector stocks have lagged the broader market by a wide margin.

The concentration of the US market's gains in a small number of large technology stocks is another source of unease. The S&P 500 recently hit an all-time high, yet only about one-third of its constituent stocks were trading above their 50-day and 100-day moving averages — a sign that a large portion of index members have been struggling even as the headline index climbed.

While AI-related companies have led the market higher, consumer-facing sectors have been left behind. Rising government bond yields are also adding to valuation pressure on equities, casting doubt on how long the large-cap tech-driven rally can last. If earnings at consumer companies deteriorate further, the range of sectors supporting the market's advance could narrow even more.

The bigger concern is that falling share prices could in turn suppress consumer spending. According to the Financial Times, US household wealth in stocks and retirement assets has grown by $34 trillion since late 2022. Some analysts estimate that the so-called wealth effect from rising asset prices accounted for roughly 40 percent of the increase in US consumer spending last year.

The wealth effect refers to the tendency of households to spend more when rising stock or real estate prices make them feel wealthier. The reverse is also true: a market downturn can cause households to pull back as they feel poorer. That raises the prospect of a vicious cycle in which falling share prices lead to weaker spending, which in turn hurts corporate earnings and pushes stocks lower still.

The gap in spending capacity between high- and low-income households is another variable. According to Reuters, while AI investment and rising share prices have significantly boosted US household wealth overall, the gains have been concentrated among higher-income households that hold a larger share of equities. Households with fewer financial assets such as stocks, by contrast, are feeling the direct impact of higher energy and food prices more acutely.

Goldman Sachs has also warned that elevated interest rates could simultaneously weigh on both the stock market and consumer spending. The bank estimated that rising rates could shave 0.2 percentage point off US consumption growth by 2027. It also flagged the possibility that if stock market returns stagnate, a weakening wealth effect could push consumption growth down by an additional 0.5 percentage point.

Actual consumer spending has so far remained resilient. US real retail sales rose 2.6 percent year-on-year in August, even as consumers expressed a negative view of economic conditions while continuing to spend.

Results from major banks have also shown no sharp deterioration in spending. JPMorgan Chase's credit and debit card payment volume rose 10 percent year-on-year in the third quarter. Citigroup and Wells Fargo similarly assessed that consumer spending activity remains intact. It is too early to conclude that the deterioration in sentiment has translated into an actual decline in spending.

High borrowing costs, however, are widely seen as a constraint on spending going forward. The US 30-year fixed mortgage rate has climbed to around 7.4 percent, adding pressure to home purchases and rate-sensitive spending on furniture and appliances. Higher transportation costs driven by elevated oil prices could also put additional upward pressure on goods prices.

Wall Street's attention is now focused on whether the deterioration in consumer sentiment will translate into an actual drop in spending. Retail sales data and earnings from consumer companies released ahead of the holiday shopping season are expected to serve as key benchmarks. Should US consumer spending slow, the stock market rally concentrated in AI and large-cap technology stocks will face a new test.

sjy@heraldcorp.com