Consumer sentiment is in the dumps despite a solid economy. Goldman Sachs blames 'lower happiness'

Consumer sentiment surveys show sharply declining confidence among American households even as GDP growth remains solid, unemployment stays low, and corporate earnings hold firm. Goldman Sachs economist Joseph Briggs attributes this disconnect to what he calls "lower happiness" driven by broader societal pessimism rather than economic fundamentals.

The University of Michigan Consumer Sentiment Index has tumbled significantly from its mid-2021 peak, reflecting a gap between objective economic conditions and subjective household mood. Unemployment sits near 50-year lows. The labor market continues adding jobs. Yet consumers report heightened anxiety about their financial future, unwilling to spend at rates consistent with a thriving economy.

Briggs argues this pessimism transcends traditional economic metrics. Political polarization, cultural divisions, and social media discourse create a cloud of negativity that filters how Americans perceive their own prosperity. Even households with stable incomes and rising asset values express concern about inflation, housing affordability, and economic stability. The wealth effect, which typically boosts spending when stock and home values rise, appears muted as consumer confidence lags.

This dynamic creates a puzzle for policymakers and investors. A consumer recession could arrive despite labor market strength if sentiment deteriorates further and households cut spending preemptively. Consumer spending accounts for roughly 70 percent of U.S. GDP, making household willingness to buy goods and services the economy's true engine. Weak sentiment foreshadows weaker demand, which pressures corporate margins and justifies lower equity valuations even in a non-recessionary environment.

The Goldman analysis suggests monetary policy tightening alone cannot fully explain sentiment collapse. The Federal Reserve has hiked rates aggressively to combat inflation, and higher borrowing costs do dampen confidence. But Briggs points out that real wage growth remains positive for many workers, and energy prices have retreated from 2022 peaks. Yet despair persists anyway.

This disconnect matters for 2024 investment positioning. Stock valuations assume earnings stability or growth. A sentiment-driven spending pullback would compress those earnings forecasts despite labor market resilience. Retailers and discretionary consumer stocks face headwinds even if unemployment doesn't spike. Healthcare and staple consumer sectors become relatively attractive as households prioritize necessities over wants.

The Federal Reserve watches consumer sentiment closely when setting policy. If the central bank believes sentiment reflects irrational pessimism rather than legitimate economic concern, it may hold rates steady longer. If policymakers fear sentiment predicts real demand destruction ahead, they might cut rates sooner than current forward guidance suggests.

Briggs' framing also highlights a behavioral economics reality: rational actor models fail when psychology dominates. Households make spending decisions based partly on confidence and partly on fundamentals. Remove the confidence, and the fundamentals alone cannot sustain growth. Breaking the pessimism cycle may require sources outside traditional economic policy. That leaves political and cultural shifts as potential circuit-breakers for consumer sentiment recovery.

Investors watching consumer discretionary stocks, the S&P 500 Consumer Discretionary Sector, the University of Michigan Consumer Sentiment Index, and Treasury yield curves should monitor Q1 2024 retail sales data and forward consumer spending guidance to confirm whether sentiment decline translates into actual spending weakness.