Fuel costs are surging. The finely tuned US network of transportation and distribution, not just for energy but for a broad range of commodities, has suffered a body blow. With luck, the national infrastructure will recover relatively steadily, but higher prices for a number of necessities may confront American consumers well into the autumn. When winter arrives, one hopes that supplies of key products will have rebounded, but current prices for both heating oil and natural gas are roughly double levels from a year ago.
Against this backdrop, investors seem unduly confident in the resilience of US consumer spending. US profligacy has overcome all kinds of threats in recent years, including terrorist activity, a wearying war, and soggy employment conditions. Encouraged by low interest rates, an effervescent housing market, and creative lending practices, consumers have continued to defy the prophets of doom. As we approach 2006, an improving jobs picture should further underpin consumer activity. Nevertheless, ongoing removal of monetary accommodation erodes financial flexibility, and anecdotal evidence of softness in home prices already abounds.
It is hard to know how deep and sustained any hit may become, but prices for many consumer-related shares seem ill-prepared for disappointment. Reflecting typically contango views of consumer behavior, the price/earnings ratio for the discretionary group remains second only to technology among S&P sectors, with some retailers selling for more than 30 times profits.
The devastating aftermath of Katrina has increased the likelihood of a pause in US interest rate hikes before the end of this year, raising some hope that a new wave of consumer borrowing may revive expenditures in 2006. But policy tends to act with a lag, and with inflationary pressures likely to grow in coming months, actual cuts in rates still seem a long way off indeed.
Remarkably enough, the price/earnings multiple for the energy group remains near the lowest among S&P 500 sectors, reflecting concerns for an imminent decline in profitability. Only the financials are valued with a similar skepticism. But perhaps it is the consumer stocks that should be adopting a more backwardated view of the future. As my experience in New Hampshire indicates, a more arduous reality has yet to hit home.
Daniel C. Peirce is portfolio manager, global asset allocation at State Street Global Advisors.
