A health check of the American consumer

To paraphrase Mark Twain, rumors of the death of the American consumer are greatly exaggerated. As discussed last week, during the week of May 16, fears about the American consumer increased when Walmart

WMT
(WMT) and target

TGT
(TGT) announced disappointing results. Retailers underperformed that week, and many were down around 20%.

Last week’s earnings reports from more retailers brought relief and a robust rally for the group. Retailers rose 8.8% for the week, while the S&P 500 gained 6.6%. This performance erased retailers’ steep losses of the previous week, although the group still underperformed the S&P 500 over the entire two-week period.

A little background on the impact of the pandemic on consumer spending will be useful before we dive into the trends and themes that are currently emerging. While all spending plunged in the early months of the pandemic, spending on services fell more sharply than spending on goods. Given the drive for social distancing, a drop in service spending is to be expected. With most of the population spending more time at home and bolstered by government support, spending on goods has rebounded rapidly and surpassed the pre-pandemic peak in mid-2020! With covid infections continuing to cause people to avoid personal contact, spending on services only exceeded pre-covid levels in mid-2021.

Retailers’ first-quarter profits echo macro data, which shows spending on services is now growing faster than spending on goods. Spending has also shifted towards consumables such as food, beverages and fuel versus general merchandise in goods spending. Walmart and Target both posted higher revenue (sales) compared to the same quarter last year, so consumers are still spending. Households appear to be shifting towards more service spending, especially travel and leisure, at the expense of household purchases like furniture. For example, Southwest Airlines

LUV
(LUV) and JetBlue Airways

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(JBLU) recently announced in advance that second-quarter revenue tended to be higher than expected.

Costs due to inflation are also weighing on their revenues, but stores have generally been able to pass on some of the increases to consumers. Supply chain costs weighed on earnings in the quarter. Companies with a high percentage of imports have been hit with massive increases in ocean freight costs. Walmart and Target have a large portion of imported items, which also helps explain the shortfalls. The reception deposit

HD
(HD) has many imported products but owns several container ships, which has allowed it to avoid some pressure on shipping costs. General dollar

CEO
(DG) and Dollar Tree

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(DLTR) showed resilience in the discount store category last week, focusing on selling basic consumables to low-income households and reducing exposure to higher shipping costs for imported goods. Changing spending habits combined with supply chain challenges have left some retailers stuck with excess inventory for the first time since the rebound from the pandemic.

There is evidence that the low-end consumer is feeling the pinch of rising food and fuel prices. Walmart noted that some consumers were returning to private label offerings, and discounters reported greater demand for basic consumable items versus general merchandise.

Despite the inflationary challenges facing consumers, households have accumulated significant savings that can be used to supplement their incomes to support consumption. Currently, however, depressed consumer confidence poses a risk to consumer spending.

In summary, macro data and corporate earnings point to a shift in consumer spending themes rather than the end of US consumer strength. According to JPMorgan (JPM), Chase credit card spending increased every month from February to May. While the odds of a recession in 2023 increase as the Federal Reserve continues to hike rates to fight inflation, strong consumer spending makes an economic slowdown less likely to occur in the near term. The labor market remains crucial to these prospects. History suggests that spending should continue as long as low unemployment supports higher wages, despite declining consumer confidence. May’s jobs report will be watched closely for signs of a crack in the labor market, and weekly jobless claims will be key as a higher-frequency indicator.