J.P. Morgan's David Kelly: Consumer sentiment data isn't quite as bad as it looks

Key Concepts

• Consumer sentiment vs. consumer behavior
• Business behavior and reluctance to lay off employees
• Tariffs and their impact on retail margins and consumer prices
• Uncertainty tax levied by Washington
• Dynamic labor market and its potential slowdown
• Fiscal stimulus and its impact on recession probability
• Deficit spending and its long-term consequences
• Inflation and its relationship to economic growth and government borrowing
• Diversification in investment portfolios (international, value stocks)
• Earnings matter in the long run for equity markets

Consumer Sentiment vs. Consumer Behavior

The discussion begins with the presenter noting weak consumer sentiment data. David Kelly downplays the significance of the sentiment data, citing a small sample size (250-300 people) and a change in survey methodology (from telephone to online interviews) that may have skewed the results negatively by as much as six points. He argues that while consumer resilience is being tested by tariffs, student loans, and government cutbacks, the key factor is business behavior.

Business Behavior and Reluctance to Lay Off Employees

Kelly emphasizes that businesses are hesitant to lay off employees due to the difficulty they faced in hiring in recent years. They are waiting to see the full impact of tariffs before making drastic decisions. Retailers, for example, are absorbing some of the tariff costs in their margins rather than immediately raising prices, playing a "wait and see" game.

Tariffs and Their Impact on Retail Margins and Consumer Prices

The conversation highlights that retailers are currently absorbing some of the tariff costs, impacting their margins. However, they anticipate marking up prices on new inventory arriving at ports to reflect the increased costs due to tariffs. This strategy reflects a cautious approach, waiting to assess the full economic impact before fully passing costs onto consumers.

Uncertainty Tax Levied by Washington

Kelly introduces the concept of an "uncertainty tax" levied by Washington, which he argues is more significant than all other taxes combined. This uncertainty stems from the unpredictable policy environment, causing businesses to freeze decision-making, including hiring.

Dynamic Labor Market and Its Potential Slowdown

The US labor market is described as highly dynamic, with 65 million people hired annually. Kelly suggests that even a slight pause in hiring decisions due to uncertainty can significantly slow down the economy. He uses the analogy of 250,000 car starts per day, implying that even a small disruption can have a large cumulative effect.

Fiscal Stimulus and Its Impact on Recession Probability

The pullback on tariffs and the tax bill, which provides stimulus into 2026 and some in 2025, are seen as factors that reduce the likelihood of a recession this year. These measures provide a buffer against economic slowdown.

Deficit Spending and Its Long-Term Consequences

Despite the short-term stimulus, Kelly warns about the long-term consequences of increasing deficit spending. He projects that the deficit will approach 7% of GDP in four years, up from 6% currently, indicating a concerning trend. He criticizes the "fiscal fudge" of paying for tax cuts with future spending cuts, a common practice.

Inflation and Its Relationship to Economic Growth and Government Borrowing

Kelly argues that inflation is unlikely to collapse if the economy avoids a collapse. He points to factors like near-full employment, limited available workers, and ongoing tariff issues. The government's heavy borrowing to finance the deficit makes it difficult for the long end of the bond market to rally strongly.

Diversification in Investment Portfolios

Kelly advises investors to temper their expectations for US equities and fixed income, as the 60/40 portfolio may not deliver the same returns as in the past. He recommends diversifying into international markets and value stocks.

Earnings Matter

Despite the tendency to "buy the dip," Kelly emphasizes that earnings ultimately matter for equity markets. Even if consumer confidence is low, the underlying financial performance of companies will eventually drive market trends.

Conclusion

The US economy faces a complex situation with conflicting forces. While consumer resilience and fiscal stimulus provide some support, the uncertainty created by tariffs and increasing deficit spending pose significant risks. Businesses are hesitant to make long-term commitments, and the labor market could slow down. Investors should diversify their portfolios and temper their expectations for future returns. The key takeaway is that while a recession may be avoided in the short term, the long-term outlook is uncertain and requires a cautious approach.