US premium wine rides on household wealth boom, but ‘headwinds' are gaining, says Wells Fargo economist
While U.S. interest rates remain at low single-digit levels, increases could cut into consumer wage and investment income, and that could prove challenging for how much they have to spend on wine, according to a national economist.
The North Bay Business Journal talked with Gary Schlossberg, senior economist for Wells Capital Management, a fee-based, institutional money manager with more than $340 billion in assets under management. In that role, he analyzes the economic, financial and investment environment for investors as well as banking groups within Wells Fargo & Co.
Schlossberg is a member of Wells Capital's Investment Policy and Liquidity Management strategy committees. He has been with Wells Fargo since 1974. Before that, he researched international economics for the U.S. Treasury Department and Federal Reserve Board.
In conjunction with Schlossberg's presentation on the U.S. and global economy at the Business Journal's Wine Industry Conference in April, the Journal talked with him about the how deep the pockets go for consumers' disposable income.
Wine consumption is often associated with disposable income. In the current environment, do consumers have more access to cash to spend now versus the past?
We're in the sweet spot of an economic cycle. This one has been unique. It's been very long, very drawn-out after the financial meltdown. A lot of it has been due to the adjustment. Rebuilding bank balance sheets, so they can lend again. Rebuilding household balance sheets.
In the labor market, not only has there been a mismatch between skilled and unskilled. The skilled portion tend to have more discretionary income and have done better in this environment. There unemployment is lower, (and) their wages have gone up more rapidly than those in the unskilled sector.
All that plays to wine consumption — any discretionary item.
We're really late in an economic cycle, before inflation really starts to squeeze income. We're seeing even less of inflation taking off than usual this time around, although it is starting to firm a little bit.
It's usually this late growth-cycle stage, when people are about as flush (with funds), confidence levels are high. Just beyond this — and I think it will be more drawn-out this time around — you will start seeing interest rates moving up enough to start squeezing economic activity. Higher inflation starts to squeeze incomes.
So how far can vintners go with growth in premium wines?
It is driven by the rapid buildup in household wealth, and it really has been skewed to upper-income families. If you look at increases in wealth, we have seen very little of it in middle- and lower-income segments.
It seems to me that premium wine consumption of the kind that Napa and Sonoma are known for is driven by upper-income growth and growth in wealth, which means a spillover in consumer confidence and well-being. You're firing on both engines right now.
Income growth hasn't been explosive, partly because inflation hasn't gone up that much. So there isn't a need to match or exceed inflation. Real income growth, adjusted for inflation, hasn't grown that rapidly in this environment.
But as interest rates rise and eventually impinge on (economic) growth, you will see a slowing in wage growth. That's going to happen later than sooner, perhaps sometime next year.
Increasing rates could create a headwind for financial assets and risk more corrections in the market. I'm not talking about the kind of meltdown we went through a decade ago, but the rally in the market blunted on the margin.
These would create headwinds for wine consumption in general and premium consumption in particular. The only wrinkle there is after years of moving into that upper end, it probably would take a wrenching in the economy and a big correction in the market to have a dramatic effect on the premium end.
We're looking at a period where things are really ideal. I wouldn't call it perfection, by any means, but this is about as good as it gets cyclically in the economy.
Upper-income families have enjoyed a pretty good labor market and an excellent market for financial assets. As interest rates and inflation went down, bond prices and stock price valuations can become more inflated, because they're competing against more-expensive bonds. Everything seemed to be clicking.
If there is talk about how high wine prices can go, if there is concern about pushing the envelope now, that may be more of an issue if things play out in the economy at the macro level as we expect.
I don't mean to make this appear overly stark. This has been a slow-motion economic cycle. Given the outlook for inflation and the Fed's caution in raising interest rates, all this will be very gradual. You're more likely to see an erosion of the (economic) environment.
I can see an environment where there aren't as many tailwinds favoring discretionary spending. In a way, we're moving back to normality.
There are risks. There are distortions in the market, and even modest increases in rates could create more turbulence. I would see that as more of a risk than a likely scenario. That's where economics is more of an art than a science.
How will increasing interest rates affect consumer behavior?
In terms of discretionary income, these may be the best of times. They may be good going forward, but they won't be quite as good. We're looking for inflation to pick up. We're still talking about low single digits, just not as low as we've seen.
As interest rates begin to move up in response to firming inflation, you don't typically see it right away biting into economic activity. That's why the stock market can continue to do fairly well during the early and middle stages of an interest-rate upcycle.
The Fed is going to try to avoid interest rates biting into economic activity. Their sense is that the economy is still fragile. When rates do begin to bite, that's when you see the pattern of spending begin to change. That's when you see the stock market valuations begin to slow, because (higher interest rates) are beginning to affect the earnings outlook. But right now, earnings in the stock market are quite strong.
Contact Jeff Quackenbush at firstname.lastname@example.org or 707-521-4256.