Even as the stock market chugs up the wall of worry, we were reminded today that the economic fundamentals remain mired in simply unprecedented territory. As you can see in the first chart below, April saw both the largest increase ever in personal income (blue line) and the largest ever decline in personal consumption expenditure. Importantly, personal consumption expenditure fell fully 30% more than personal income rose, implying that all that “income” (i.e. stimulus payments) was saved. Indeed, the second chart below shows that savings rate rose to 33%, for which there really are no words.
Sure, that is April data reflective of when the economy was shut down and so can be thought of as a “one off”. I get it. But what if, as seems likely, the savings rate remains elevated for some time as companies rationalize labor on the back of lower sales? A US consumer that saves more and spends less is a recipe for lower price earnings ratios, as can be seen in the next chart below. Indeed, the savings rate is highly inversely correlated with the S&P 500 PE ratio.
So what does this say about current valuations? It implies that the equity market is expecting a full recovery in consumption. Place your bets.