State of the Consumer

For those of you who would prefer to listen:

Americans keep spending. GDP (Gross Domestic Product) grew at an annualized rate of 2.4% in Q2. Strong consumer spending led. The Fed’s staff subsequently canceled its prediction for a recession, given the resilience of the Economy. Retail sales increased 0.7% in July, a much stronger-than-expected result. The Street modeled 0.4% growth. That translates to a 3.2% year-over-year increase. Consumer spending accounts for 70% of America’s economic activity. It’s still strong. Cars and Health Care spending were the standout strength, up 8% each. 

Non-store retail purchases increased nearly 2% in July alone and 10% over the last year. That could very well be the result of Amazon’s Prime Day, which had record sales. It was so good that Amazon announced another one is coming in October. Online transactions continue to take share of total consumer spending, accounting for over 15% of total sales. It was less than 6% a decade ago. Covid accelerated the trend that was already in place. The trend is clearly irreversible.

The category that includes furniture and home furnishings fell 1.8% month-over-month and 6.3% year-over-year. This is yet another indication that American consumers are backing away from big-ticket items. Home Depot reported earnings this week and acknowledged big-ticket demand has indeed slipped. Management stated its customers are still spending on smaller projects but seem to be deferring the larger ones for later. 

Spending patterns are watched closely, especially for items like apparel, food, furnishings and electronics. They’re the key dashboard indicators for America’s economic engine. Earnings reports also give a clearer read on consumer behavior and the response to higher prices. If costs rise by a smaller amount or even dip, that can impact spending patterns, especially in an era of low unemployment. More spending can also influence company profit margins and inventories, which retailers track and share on their earnings calls. Import and transportation prices were higher than expected, indicating inflation is still an issue. 

Walmart and Target also reported earnings this week and highlighted strong back-to-school trends. Half of Walmart revenues come from groceries, which have been consistently solid. E-commerce increased 24% in the June quarter. Walmart’s CEO felt encouraged that it bodes well for the Holidays, which is by far the biggest season for stores. One major problem that retailers are facing with increasing frequency: Theft. It’s a major problem. There are few signs of improvement. 

Retailers call it “shrinkage.” The term reflects loss of inventory, which can be defined as lost, damaged or stolen. Stealing has been on the rise. Total shrink last year was a reported $94 Billion. It’s already looking worse for this year. Target said its stores saw a 120% increase in thefts which included violence towards employees in just the first 5 months of 2023. The company expects $1 Billion in losses for the full year. 

Crime and violence are destroying America’s vibrant cities. People are avoiding them with increasing frequency. Consumers aren’t consuming in the city like before. It’s hurting stores. Gump’s, a San Francisco institution for over a century and a half, just pleaded to the Mayor and the California Governor to take action or it will be forced to shut its doors in Union Square for good. Gump’s cited increased violence, homelessness, and the reduction in workers in the office, which is putting permanent pressure on its ability to survive. They’re not alone. Retailers face it across the country.

A Nordstrom in Los Angeles had $300K in merchandise stolen within minutes by what clearly was an organized theft. It was a flash mob, masked and dressed in silver and black. The merchandise is stolen and seemingly re-sold to unsuspecting buyers online. It’s become big business. There could be well over $100 Billion in stolen goods this year in America, from coast to coast. Tourists are being turned off by what’s happening. Locals are too. Nordstrom already announced it is closing the San Francisco store.

China’s Economy is weakening. The economic re-opening after an extended lock-up period from zero Covid policy has seemingly stalled. It’s surprising pretty much everyone; Particularly the Chinese government. Consumer spending accounts for 40% of Chinese GDP. The Chinese people are not spending how they did pre-Covid. Retail sales grew just 2.5% last month. 4.5% growth was expected. Real estate investment was down 8.5%. New home prices fell in July for the first time this year. Bank loans fell to a 14-year low last month while deflation is setting in and exports are contracting.

China’s largest real estate developer filed bankruptcy this week. It was allegedly swimming in debt. The Property market is so important to China’s Economy. Real Estate accounts for 1/4 of Chinese GDP. It’s looking increasingly likely that China misses its 5% economic growth target. What was supposed to be a boom is now looking like a bust in China.

Inflation is not a problem in China. The country is actually facing deflationary pressures. Consumer demand is shrinking, and fast. Youth unemployment is 21%. It’s horrifically high. The Chinese government just said it will no longer report this metric. Right, that should work… You don’t like the number, so you stop reporting it? What’s next?? That said, we could never trust numbers out of China anyway. There’s a buzz that the youth unemployment is actually far worse, and the government is covering it up. 

President Xi has been noticeably silent on the subject. His style is to always project strength. China incessantly asserts itself on the World stage as a clear alternative to America’s might. It’s looking more and more hollow. China is the second-largest global economy. It matters to the Market. China is in tough shape right now. The Market is reflecting it more and more by the day. 

China’s weakness is especially felt in Europe, which exports a great deal to the Asian nation. It also relies on Chinese imports. Companies from around the globe have been reconfiguring their supply chains, reducing China dependency after learning a hard lesson during Covid. But China also represents a huge market opportunity with 1.4 Billion consumers. They’re not consuming like they once were. The impact is felt in this connected World in which we live. 

One area of global economic strength can be found in another Asian nation: Japan. The Japanese Economy just reported 6% growth. Those are China-like numbers. Well, what China used to do. The strength was driven by tourism and exports. The weak Yen currency has made Japan more affordable. Consumer spending was on the weaker side though, with the Economy relying on international spends. That could cause a pause to the 3-consecutive quarterly economic expansions. But bigger picture, there is a Renaissance at hand in Japan. After 30 years of declines, the Japanese Stock Market is humming again. In many ways, Japan is a key beneficiary from China’s struggles. 

Back to the Market:
After an explosive first half of 2023, stocks hit a brick wall in August. The AI-led exuberance has burned off a bit. A greater sense of reality seems to have returned. 

Seasonality is playing a role too. August often brings increased volatility and declines, while September has proven to be the weakest month of the year for stocks. Case in point, in the last 10 years, the S&P 500 has fallen 1.5% in September. It’s been up every other month on average over that same period. It’s another reminder that September and October often bring corrections ahead of seasonal year-end strength.

The Bond Market keeps telling a cautious tale. Yields keep rising. Yields are rates of interest payments on borrowed money. Interest rates are the price of money. The price keeps going up. The benchmark 10-Year Treasury yield reached 4.3% this week. That is a 15-year high, a level not seen since before the Financial Crisis. Mortgages, at 7%, are the highest in 2 decades. Higher rates squeeze pricing power. That slows purchase rates. Prices subsequently fall. That’s what’s happening in the Stock Market and Housing. They were both excessively valued again. A correction has begun. Housing affordability hit its worst point in 4 decades. Consumers are stretched. 

The thing is, these high yields make the Bond Market quite attractive to investors looking for predictable returns without taking as much risk. Count us in that camp. We have increased our fixed income exposure throughout the course of 2023. 

The Fed has an important and symbolic meeting next week. It will be held in Jackson Hole. It’s not a live meeting, meaning no change in interest rates will come. But the Market will be supremely focused on what is said. The Economy has remained resiliently strong. Airports, hotels, and restaurants have been packed. Retail sales show consumers still spending. Unemployment is still at 5-decade lows. This gives every reason for the Fed to keep rates high if not raise them more. That said, there are signs that these trends are slowing. 

Credit card debt eclipsed $1 Trillion for the first time ever. Interest payments on credit cards are over 20%. That’s the kind of debt that buries borrowers. We can’t say it enough, steer clear of credit card debt. 

A new survey from Credit Karma revealed that over half of borrowers say they are forced to choose between making their loan payment or covering necessities, like rent and groceries. That’s not good. As stated before, the Consumer is pretty stretched. Summer spending appears to be coming to an end. Back to school tends to result in wallet tightening too, before the Holiday rush. That sure looks like it’s in play today. 

The path of least resistance has reversed hard. For most of the year, it was decisively to the upside with the raging rally. August turned it down in a quick way. It still isn’t clear whether this is a new Bull or another vicious Bear Market rally as a continuation from 2022. You never know until it’s well in the rearview mirror. Risks are still high. The Market got to a point where it priced in so much of the good and completely ignored the not-so-good. There’s still a lot of unfinished business to attend to. The Market doesn’t seem to be ignoring that now. We see this choppy price action continuing as reality sets back in. The fact is, this is a weird, post-pandemic Economy and World. But we keep navigating through it. 

Have a nice weekend. We’ll be back, dark and early on Monday.


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