Keep your pessimism in check despite that consumer sentiment has seen one of the biggest drops in history over the last 12 months. Here’s why.
That’s worth remembering, since consumer sentiment has plunged. The University of Michigan’s Index of Consumer Sentiment has fallen more than 25 percentage points over the last year—one of its biggest 12-month declines since 1952, when the survey was first conducted. There have been only seven occasions since then in which the index fell more than that in any given 12-month period—once per decade, on average.
I summarize the historical record in the accompanying chart, which reflects data back to 1979, which is when the University of Michigan began conducting the survey on a monthly basis. The chart focuses on four different groups of months since then, sorted according to how much the University of Michigan index rose or fell over the trailing 12 months. Notice that, on average, the S&P 500’s SPX, +0.
Consumers have a tendency to extrapolate the recent past when forming their expectations of future inflation. That is, when inflation is low, they expect it to stay low. And when inflation worsens—like it has over the last 12 months—consumers expect it to stay high for at least a while longer. As a result, consumers will be most wrong at turning points—with their inflation expectations highest at the very point it’s about to come down.
Many have already weighed in on the debate over whether inflation will recede in coming months. The analysis presented here adds an additional perspective, suggesting that because consumers currently believe inflation will stay high is a reason to suspect it won’t.
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