MW If mortgage and credit rates go higher, these stocks could go lower

By Mark Hulbert

Higher borrowing costs pressure the financial, technology and consumer-discretionary sectors

Don't expect consumers to cheer up soon, even if tariff deals are reached and a trade war is averted.

Many think otherwise, since the stock market in recent weeks has gyrated wildly on any tariff news. When it looks like a trade war may be escalating, the market plunges. When there is even a rumor that conciliatory tariff negotiations may be in the works, stocks soar.

Read: Talk of a Trump pivot on China tariffs is helping stocks - but U.S. companies want actual trade deals

Still, expect American consumers to remain downbeat because borrowing costs are likely to remain high, especially for anyone wanting to buy a house. A recent academic study found that such costs - which used to be included in the consumer-price index $(CPI.UK)$ but are no longer - are significantly correlated with the University of Michigan's Index of Consumer Sentiment.

So long as consumers remain gloomy, furthermore, the U.S. economy in general, and consumer-oriented sectors in particular, are likely to struggle. A preliminary April reading of the University of Michigan's index shows that it declined to 50.8% from 57.0% in March - its lowest level since mid 2022.

The study, entitled, "The Cost of Money Is Part of the Cost of Living," was conducted by Marijn Bolhuis of the International Monetary Fund and three researchers at Harvard University: Judd Cramer; Karl Oskar Schulz, and Lawrence Summers.

The normal pattern is for the University of Michigan Index of Consumer Sentiment (UMICH) to be inversely correlated with U.S. inflation and unemployment. Given that both of these latter factors are currently low, we'd expect the UMICH at a minimum to be above average, if not higher - instead of as low as it is.

This study's authors resolve this paradox, which they refer to as the "Consumer Sentiment Anomaly," by focusing on the cost of borrowing. "We show that the lows in US consumer sentiment that cannot be explained by unemployment and official inflation are strongly correlated with borrowing costs and consumer credit supply," they wrote

To appreciate what the study's authors found, consider the mortgage-interest cost on the average new home. As you can see from the chart below, there was a rough correlation between this cost and CPI inflation up until mid-2022. Since then, as the CPI declined dramatically, the cost of housing index rose even higher.

It used to be that the costs associated with buying a house were included in the CPI. The study's authors write that, prior to 1983, the U.S. Bureau of Labor Statistics $(BLS.SI)$ reflected these costs by "taking house prices, mortgage interest rates, property taxes and insurance, and maintenance costs as inputs." Though there were problems with that approach, the authors believe that the BLS solution (calculating what's known as "owners' equivalent rent") may have created an even bigger problem, as evidenced by the current disconnect between the CPI and consumers' sense of their financial well-being.

Sectors that are likely to struggle

The investment implication of this analysis is that we should focus on where borrowing costs may be headed. If those costs decline significantly, we may want to invest in sectors that are particularly responsive to changes in consumer sentiment. If borrowing costs are likely to remain high or head even higher, then presumably we would want to underweight those sectors.

To determine which sectors are most sensitive to changes in consumer sentiment, I measured the correlation between the UMICH index and each of the S&P 500's SPX 10 major sectors. (Specifically, I focused on all rolling 12-month periods beginning in 1999.)

The three U.S. market sectors with the highest correlations are financials, technology and consumer discretionary. Each of these can be invested in via exchange-traded funds such as the Financial Select Sector SPDR XLF, the Technology Select Sector SPDR XLK and the Consumer Discretionary Select Sector SPDR XLY.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: 'Pervasive' uncertainty from trade fights depresses outlook for economy, Fed's Beige Book finds

Plus: Is recession 'inevitable'? Markets say don't be so sure.

-Mark Hulbert

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April 24, 2025 08:21 ET (12:21 GMT)

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