Is the Consumer Rolling Over?

Last week we received a strong earnings report from the world’s largest brick-and-mortar retailer, Wal-Mart. The report was highlighted by solid 3.2% growth in US same-store sales and 41% growth in US e-commerce sales. Earlier this week, we received some affirmation of the positive consumer backdrop from TJX Companies, which operates TJ Maxx and other off-price retail platforms. TJX Companies reported a beat on both the top and bottom lines. In both cases, though, the stock reaction was relatively muted, which usually means that solid results had already been anticipated. We also received a couple of negative earnings reports earlier this week from two more of the country’s largest retailers, Home Depot and Kohl’s. The stock reaction to these lackluster reports was fast and furious. When it was all said and done, Kohl’s fell a massive 19% on the day while Home Depot fell 5%. Several other retailer stocks were down in sympathy, most notably Macy’s and Nordstrom, which sold off 11% and 6%, respectively. Fast forward to yesterday, and it was a completely different story . . . again. Target and Lowe’s each reported results that exceeded expectations, and those stock are up 13% and 4%, respectively, as I write.

What are we to make of these seemingly contradictory reports? Are we finally seeing some cracks in the heretofore dependable US consumer, or are we just seeing market share shifts (to Amazon and Walmart, for instance) in an otherwise healthy consumer environment? From where I sit, the jury is still out. To be sure, there have been other recent data points that could be cause for concern. The Retail Sales report for October, which was released last week, was a little better than expected on a headline basis (+0.3% compared to +0.2%). However, there was some softness embedded in the headline number. If we exclude automobile and gasoline sales, Retail Sales were only up a less-than-expected 0.1%. A Bloomberg article by Reade Pickert read, “But the report also included some signs that may point to consumers running low on steam, with seven of 13 major categories dropping.” Is this a disaster? Absolutely not, but it is a preliminary sign that the weakness in manufacturing and business investment that has plagued the economy for months could be starting to spill over to the consumer.

Gauges of consumer confidence have also been trending lower in recent months, albeit from very high levels. Last week we learned that the Bloomberg Consumer Comfort Index, reported weekly, fell by 5.4 points in just three weeks – the largest such drop since February, 2008. An article on Bloomberg by William Edwards had this to say: “Comfort for those making less than $50,000 decreased for a 10th straight week, extending the longest streak of declines in data since 2010.” Quoting Gary Langer, head of Langer Research Associates (who conducts the survey for Bloomberg), Edwards went on to say, “The declines in consumer comfort ‘initially focused on lower-income households, have now been expanding in recent weeks to middle-income households,’ he said in an interview. ‘Better-off folks are still well insulated.'”

In an effort to gauge the trends in consumer confidence we put together a composite index consisting of three widely used indices that track consumer well-being. In the chart below, the blue line represents average levels for the University of Michigan Consumer Sentiment Index, the Confidence Board Consumer Confidence Index, and the Bloomberg Consumer Comfort Index. You will see that the composite index has retreated somewhat from the highs over early this year. To be precise, the composite has dropped about 7% since July. This may seem like a lot, but the composite index is still at very healthy levels and about 13% above the level in January of 2017. My interpretation of this chart, then, would be that consumer confidence remains high but somewhat off the euphoric levels seen during the summer.

The mixed earnings reports from the retailers and the pullback in consumer confidence should be taken in stride. After all, the consumer has done fabulously well in recent months/years despite weakness in almost every other component of our GDP, right? The unemployment rate, at 3.6%, remains very close to a 5-decade low. Wage growth has slowed from the 10-year high over 3.4% in February of this year, but it still looks pretty good compared to recent history at 3.0% in each of September and October. The consumer savings rate is quite healthy, and the consumer’s ability to cover his fixed costs, represented by the Fed’s Household Debt Service Ratio, is also at its healthiest level in decades. These metrics are all very encouraging. Or is there something in the narrative that we might be missing?

We have long argued that most of the metrics that we and others track to gauge consumer financial health don’t tell the full story. More specifically, the metrics provide little information as to exactly who is enjoying benefits of the steady economic growth since the Great Recession. In other words, who is enjoying the lion’s share of the aggregate increases in incomes, spending and saving? If you’ve read our past Market Commentaries, you’ll know that a relatively small percentage of well-to-do folks have seen the biggest benefits while lower- and middle-class folks continue to struggle. True, middle-class wages have started to grow at a faster pace. But wage gains of 3% annually instead of 2% will not make up for the decades of stagnancy in middle-class incomes. What’s more, widely used metrics also don’t tell us much about the expense side of the consumer-health equation. We have written in previous Market Commentaries about how prices for non-discretionary goods and services have been rising much faster than prices for more discretionary categories. If this is indeed the case, and we also know that most of the income gains are going to a relatively small percentage of wealthier folks, then it is safe to conclude that a large chunk of the population continues to get squeezed by weak income growth and rising non-discretionary expenses. To further muddy the waters, much of the middle-class owns very little stock and/or rents their home, meaning they have not participated in the huge increase in asset prices.

The fourth quarter will be a huge test for the retailers and for the economy at large. Some economists are already reducing their expectations for fourth-quarter GDP growth to below 1%. The consumer has been carrying the weight of the economy for a while now as businesses continue to retrench on weak global growth, a strong dollar and the trade war with China. It is highly unlikely a gridlocked Congress will be able to provide meaningful fiscal stimulus over the near term. We have heard reports today that the first phase of an agreement with China may slip into next year. If that’s the case, the consumer will need to hang in there a while longer before getting help from other sectors of the economy. The near-term fate for the stock market rests on the almighty US consumer. But isn’t this how it’s always been?