Transcript

Amada Agati:  

In this special edition of "Adding Alpha," we check in on the U.S. consumer.

With 70% of GDP tied to consumption in some way, shape, or form, it's absolutely critical that we get the health of the U.S. consumer "right" in terms of gauging the path forward.

On Wednesday, May 18th, stocks suffered their sharpest one-day decline since June 2020, led lower by a surprisingly disappointing earnings report from Target.

Walmart had a similarly negative result on Monday.

This one-two punch from two bellwether retailers really sent shock waves through the markets.

Could this be the earliest indication of the steadfast U.S. consumer finally beginning to break down?

Could this also be confirmation a recession may indeed be on the near-term horizon?

We believe the answer to these questions is actually no, that this is much more a function of company-specific execution missteps rather than an indictment on the health of the consumer.

Target's results were especially surprising since they actually beat on revenue growth, but operating margins compressed significantly as inventories build and came in much higher than expected, and they ended up lowering earnings guidance by a whopping 28%.

This was a particularly frustrating and, frankly, confusing outcome for investors, especially considering Target management just raised margin expansion guidance last quarter.

With inflation sitting near 40-year highs and the most recent CPI reading sitting at about 8.2% the head winds this dynamic has created for the U.S. consumer are absolutely legitimate, and investors are right to be cautious.

However, despite being in the slowing-expansion phase of this cycle -- and later innings, too -- the U.S. consumer is in surprisingly good condition.

This is a notable departure from similar stages of prior cycles where consumer balance sheets have tended to be much less liquid and more over-levered.

A collective $2 trillion in excess savings remains on U.S. consumer balance sheets, and the debt-service ratio, a simple measure of household leverage, is sitting right at the 30-year average.

Personal savings as a percentage of disposable income is also a healthy 6.2%, and this compares pretty favorably to the long-run average savings rate of about 5.9%.

Retail sales data overall continued to remain really strong at 8.2%, accelerating about 90 basis points sequentially.

Comparing to prior cycles, retail sales is far from indicating an economic contraction is on the near-term horizon.

Back in December of 2007, retail sales growth was only 2.9%.

Back in March of 2001, it was just 0.5%.

Even the high-frequency data points that we've been using as a guide for consumer behavior over the course of the pandemic still look really solid.

That is, the pent-up demand from the lockdowns of the last two years continues to be unleashed.

OpenTable restaurant reservations are near their highest level of the past 12 months and only about 2% below pre-pandemic activity in 2019.

We've really come a long way since then.

Johnson Redbook same-store-sales registered a whopping 13.1% year-over-year growth last week and continued to point toward strong consumer spending activity.

Even U.S. airline passenger traffic is finally back to pre-pandemic levels.

Despite all of the strength and the underlying fundamentals and health of the consumer, consumer sentiment remains in deeply negative territory.

What's notable, though, is that this has actually been a head wind for the markets ever since the onset of the pandemic.

We haven't come close to pre-pandemic levels even in the face of last year's amazingly strong bull-market rally.

Last week's University of Michigan consumer sentiment survey not only missed consensus estimates, but actually fell to the lowest level since the U.S. debt downgrade in 2011.

Even the weekly AAII bullish/bearish sentiment reading is below March of 2020 levels.

That being said, we still believe there's time left on the clock and there's still runway left in the cycle, but we do need to see stronger evidence that inflation has peaked for these recessionary fears to begin to subside.

While one data point does not certainly make a trend, inflation does appear to be stabilizing, albeit at very high levels.

Sustained progress on this front over the summer can go a really long way to helping rally consumer sentiment and ultimately become the tailwind the market hasn't had in the last two years.

While we wait for additional evidence on this front, we do think the U.S. consumer is still strong enough to hold on, so don't stop believin' in the U.S. consumer.