Consumer spending accounts for more than two-thirds of U.S. economic activity. But the resilience of the American consumer is being put to the test. Inflation has flared to highs not seen in 40 years, spurring a rapid decline in real wages. Borrowing rates have galloped too. Job numbers have held strong so far but layoff whispers are turning into a chorus.
Yet even as U.S. GDP declined slightly in the first two quarters of 2022, inflation-adjusted consumer spending continued to rise, albeit at a sluggish 1% annual rate in Q2. And that's a good sign for the U.S. economy. While the outlook could change if the job market crumples, consumers' stamina suggests the U.S. can avoid a serious downturn.
Americans seem to be shifting their spending from goods to services, however. That makes sense, since they spent so much on furniture and electronics during the pandemic when they couldn't travel or dine out. Changes in spending patterns will create winners and losers across different sectors, such as housing, autos, travel, retail and technology.
Sectors: Stock Winners And Losers
Homebuilders including D.R. Horton are cutting guidance as sales tumble on higher interest rates. Walmart, Best Buy and RH have warned on demand for big-ticket discretionary items. Amazon.com is struggling amid a shift away from goods and e-commerce, even as AMZN stock rebounds on cloud-computing strength.
General Motors, Ford and the automotive industry may be an exception to weakness in discretionary goods due to pent-up demand as supply chain problems ease. Among tech stocks, Apple beat profit views and predicted stronger revenue growth ahead, though that could reflect improved production and demand from China, which is reopening after a recent Covid surge lockdown.
Travel and restaurant operators such as Delta Air Lines, Marriott International, Chipotle Mexican Grill and McDonald's are faring relatively well.
Leisure stocks such as restaurants, car rental companies, hotels and airlines may see a slowdown from current summer levels, but post-pandemic demand remains ample, says economist Ed Yardeni of Yardeni Research.
"One of the consequences of the pandemic is that a lot of us avoided the virus, but we all got cabin fever," he said.
Still, consumer stocks have struggled in 2022 broadly. That's partly due to the overall bear market. But even companies with resilient consumer demand face higher costs, threatening historically high profit margins.
Employment Is Key To Consumer Spending
The job market is the big wild card. As long as most people remain employed, many sectors may ride out the current weak U.S. economy relatively well as the American consumer powers through an economic slowdown.
"Americans are amazing people," Yardeni said. "When we're happy we spend money, when we're depressed we spend even more, if we have it."
Job statistics so far show a mixed bag. Hiring freezes have become commonplace, while jobless claims have risen to eight-month highs. Still, job gains have remained healthy, with a whopping 528,000 jobs added in July, according to nonfarm payrolls. Economists were expecting 250,000 added jobs. The U.S. has now reclaimed all its Covid pandemic job losses.
The unemployment rate ticked down to 3.5%, matching a 53-year low. Leisure and hospitality saw the biggest job gains, although most sectors saw an increase. Average wages increased 0.5% from June, and 5.2% vs. a year earlier. However, the labor participation rate ticked lower to 62.1% from 62.2 last month.
Can Wages Keep Up With Inflation?
Incomes are another critical yardstick. Yardeni points to rising wages among lower-income workers as a sign that consumer spending may not fall off a cliff. But it's not all good news, he cautions. For one, their wage increases often haven't kept up with inflation.
"Wages have been increasing at a more rapid pace," Yardeni said. "But the bad news is that spending on essentials is a significant portion of their budget."
Meanwhile, higher-income workers have seen smaller wage gains in the current U.S. economic climate. And the stock market sell-off during much of 2022 slashed investment income and retirement accounts. Still, Yardeni says wealthier people may have excess savings they can dip into if they choose not to cut back on discretionary spending.
Jefferies managing director and retail analyst Stephanie Wissink describes the state of the American consumer as "financially healthy, but fearful." Consumers act out of fear and emotion, she adds. The more financially confident you are, the more you spend and vice versa.
Wissink says Americans are "bummed out." While they don't like to pay more for goods and services, they also don't want to give up their way of life if they can still afford it, she told IBD.
Consumer Spending: Confidence Sliding
Consumer confidence is slumping below levels seen at the beginning of the pandemic. A recent IBD/TIPP poll shows that 58% of respondents think the U.S. economy is already in a recession. The online survey of 1,643 adults from July 6-9 shows that 91% are concerned about inflation.
"It will be interesting to see if deflating gas prices will smooth out some of the broader fear," Wissink told IBD.
Only 19% of the IBD/TIPP Poll respondents think wage increases are keeping up with inflation. Three-quarters of those polled have cut back on household spending. Most households say they are spending less on entertainment, eating out and travel. And 90% have postponed the purchase of a big-ticket item for their homes.
Even among stock market investors, a usually confident bunch, the recent bear market jolted 56% of those surveyed into high alert. Around a third of those with investments sought safer assets, with 19% going full or partial cash. Only 29% increased their investments. Stocks hit a recent bottom in mid-June, with big gains in July for the S&P 500 and other major indexes. Whether the rally will endure remains to be seen.
Housing Stocks In The Cellar
If there is one consumer-focused area that Yardeni sees as most vulnerable, it's housing and furnishings. Rising borrowing rates are eating away at affordability.
Higher mortgage rates have cooled the hot housing market, though rates are backing off recent peaks. Most experts caution house hunters not to lock in purchases just yet as prices are likely to keep coming down.
On the flip side, if you're building your new home, sky-high lumber prices are normalizing.
Homebuilder stocks like Pulte Group and D.R. Horton peaked in December and sold off hard for much of 2022 as the Federal Reserve began tightening and interest rates rose. While sales and profits were strong the last several quarters, Pulte Group missed views recently, while D.R. Horton guided lower.
New-home sales have trended lower in 2022, while existing-home sales have declined for five straight months. Housing starts have tumbled.
Mortgage rates have come down sharply over the past several weeks, and home prices are also starting to drop. That should ultimately lure in buyers, but not yet.
Home Renovation Boom Slows
Meanwhile, the renovation craze fueled by folks stuck at home during the pandemic is virtually over. RH stock had an impressive run, racing to an all-time high of 744.56 in August 2021. But shares have since tumbled, trading recently around 280. In late June, the luxury home furnishings retailer warned that annual sales will fall 2% to 5% vs. prior expectations of flat to up 2%.
Home Depot and Lowe's struggled to keep up with demand during the pandemic-fueled remodeling boom. They now face shelves full of construction materials as homeowners put off unnecessary renovations.
The SPDR S&P Homebuilders ETF, which includes Home Depot stock and RH along with builders such as D.R. Horton, has rebounded above its slumping 50-day line in recent weeks as interest rates have come down significantly since mid-June. But it's still 25% off its 52-week high.
Retailers Offer A Mixed Consumer Spending Outlook
Inventory challenges continue to plague retailers. Pandemic-era empty shelves have given way to overstocked warehouses. That's good news for bargain hunters, but discounted goods don't bring in much in profit margins.
Around 65% of Walmart's business is on consumables like groceries and health and beauty products, Wissink says. The typical shopper takes weekly trips to replenish these supplies. The rest of Walmart's sales come from discretionary items like consumer electronics, toys and furniture. That part of the business, which is usually higher margin, is getting squeezed.
Big inventory bets on discretionary goods haven't panned out for Walmart and others, Wissink says. As a result, Walmart expects adjusted EPS for the full year to fall 11% to 13%, vs. an earlier view for a 1% decline.
Best Buy saw its stock propel to an all-time high of 141.97 last November, thanks to both the meme-stock craze and robust sales. But shares have since fallen to around 96. Sales and profits declined year-over-year in the last two quarters. Best Buy recently guided lower.
Meanwhile, Monness Crespi Hardt analyst Brian White said in a note to clients that shoppers might delay buying the new Apple iPhone 14 in the fall, possibly waiting until "this economic inferno" passes. But Apple stock has rebounded solidly in the past few days, retaking its 200-day line on July 29 following better-than-expected earnings.
Bargain Retailers Ready For A Pickup
Amazon and other e-commerce plays have seen demand wane in recent months as shoppers shift away from goods and more people return to physical stores. That's left Amazon with idle workers and warehouses.
Bargain-centered retailers like Dollar Tree and Dollar General stand to benefit as consumers pinch their pennies. And Ollie's Bargain Outlet, which acquires and resells retailers' excess inventory, could benefit from overstocked mass retailers.
Consumer Spending Turns To Travel
Post-pandemic revenge travel was a trend for a hot minute. And with the euro now on par with the U.S. dollar, a European getaway is still a popular option.
At the same time, reality is setting in for a lot of Americans. The IBD/TIPP poll shows that 89% of those surveyed are cutting back on holiday and vacation spending.
Some people are planning shorter trips. Others are compensating for high fuel costs by opting for cheaper lodging and restaurants.
Airline stocks have rebounded from pandemic lows, but high fuel costs and flight disruptions due to labor shortages are offsetting big fare increases.
Delta, American Airlines and United Airlines all last month reported their best profits since the pandemic, but still missed Wall Street estimates.
Hotel stocks like Marriott and Wyndham, avoiding airlines' flight and fuel issues, have posted several strong quarters of earnings in a row. Hotel giants are expected to report record or near-record profits in 2022, with further gains in 2023.
The travel sector will face a test once demand subsides after the summer frenzy. But lucrative business travel could pick up to fill the gap in the fall.
Las Vegas tourism, a strong indicator for both leisure and business travel, is picking up. In June, the number of visitors to Las Vegas jumped 12% year over year, according to data compiled by the Las Vegas Convention and Visitors Authority. However, traffic has not returned to pre-pandemic levels yet.
Food Prices And Restaurant Stocks
With rising food costs, consumers might have to choose groceries over eating out more often. But McDonald's noted in its Q2 earnings call that prices for food at home are rising faster than for food outside the home.
McDonald's has strung together six straight quarters of profit growth, despite higher food and labor costs. Chipotle earnings have increased for the past seven quarters.
Shares of Chipotle and Wingstop soared on earnings in late July; both are trying to rebound from long declines. McDonald's stock moved toward record highs after its results.
Food costs might be ready to cool off, with wheat and corn futures well off spring peaks.
A Varied Outlook For Entertainment Stocks
As American consumers tighten their belts, entertainment stocks like Disney and Netflix may feel the pinch.
CFRA Research director and analyst Kenneth Leon sees weaker attendance at theme parks in 2023 due to recession. "Also, there is uncertainty to reopening or potential closings again of the Hong Kong and Shanghai parks due to Covid," he said in a July 19 note to clients.
Movie-theater chain AMC Entertainment could benefit from a post-Covid rebound as more folks head out for entertainment.
AMC stock tumbled after skyrocketing during the meme-stock craze. In Q1 2022, AMC sales surged 430% year over year to $786 million but was still well below pre-pandemic levels. Losses narrowed to 52 cents a share from $1.52 a year earlier, but AMC faces a long road to profitability.
A return to theaters, coupled with inflation worries, may not be a good sign for streaming services. The IBD/TIPP poll revealed that nearly 80% of those surveyed planned to give up their memberships and subscriptions.
Netflix has seen its subscriber count fall in recent months. To counter declining subscriptions, Netflix will roll out a lower-priced, ad-supported service.
Auto Stocks Are An Exception
The auto industry could be a special case. Production was restricted due to supply-chain challenges going back more than a year. So the impact of a consumer-spending slowdown may not be as big as in previous recessions.
"While autos are no 'safe haven' during economic slowdowns, an idiosyncratic combination of factors (already depressed seasonally adjusted annual rate, drained inventory, high capex starting point) may mean portions of the sector may prove more resilient than they have historically," wrote Morgan Stanley analyst Adam Jonas in a recent note to clients.
General Motors, Ford and other automakers are upbeat that the second half of the year will be stronger than the first as chip shortages finally start to ease. Vehicle pricing may come under pressure, but perhaps not right away.
Bottom Line On Consumer Spending
For the near term, the state of the American consumer appears to be resilient, perhaps even resistant to the constant headlines predicting recession is just around the corner or already here. Buoyed by still-solid job prospects and salary bumps, consumers seem focused on riding out inflation pain to spend on travel, dining out and other entertainment.
Average nationwide retail gasoline prices have tumbled to $4.059 a gallon as of Aug. 8 vs. the record $5.016 a gallon on June 14. Food prices also should moderate in the coming months. That could provide a bit of relief for low- and moderate-income households.
How long American consumers can remain upbeat is not clear. If the housing sector is any indication, consumers can pull back when affordability wanes. They may still have ample disposable savings to keep spending for a while longer. Eventually, though, they will work through those savings, and any major downturn in the jobs picture could put the brakes on enthusiastic spending.
Follow Adelia Cellini Linecker on Twitter @IBD_Adelia.
