Hi Everyone 👋,

More and more focus has shifted towards the consumer.

Since household spending accounts for around 60% of GDP figures, many are trying to gauge the strength of the individual household to forecast overall demand.

Economists are parsing through excess savings, company quarterly reports, the housing market, and inflation data to understand where the average consumer in the United States stands.

While the aftermath of Covid saw a stubbornly strong consumer, which led to stronger GDP numbers than previously expected, we’re starting to see some cracks in the system.

Since monetary policy works in lagging legs, a “higher-for-longer” rate environment that Powell forecasted at Jackson Hole could have long-term suppressive impacts on economic growth.

We’re starting to see more firms fully feel the impact of softer demand and higher rates:

When we look back at 2023, most will label it either as “The Year of AI” or the “Recession that didn’t happen.”

With plenty of economic data out this week (JOLTs, consumer confidence, GDP, PCE) let’s recalibrate where the consumer is right now and how this could trend.

• Retailer Earnings 👉 Continued Softness, Lots of “Shrinkage”

• Financials👉 Banks Had a Soft August

• Economic Data Dump 👉 JOLTs, Consumer Confidence, PCE, and NFP

Let’s get started!

1. Retailer Earnings 👉 Continued Softness, Lots of “Shrinkage”

Earlier in August, I wrote about Target, Walmart, and Home Depot’s earnings. The trend here was that those retailers that have a product mix skewed towards staples rather than discretionary were more insulated from a potential downturn. This is exactly what happens when consumers start to get squeezed.

The trend continued the following week and again into last week as we had Gap and Macy’s both miss as well. Gap said sales for all of its brands declined in the second quarter, and the apparel retailer now expects its full-year revenue to decline further than it had originally anticipated. Macy’s warned of weak consumer spending through the crucial holiday shopping season and signalled a faster-than-expected rise in credit card payment delays.

A common theme amongst retailers is inventory bloat as customers shy away from expenses in the face of inflation.

Another thing happens when consumers start to get squeezed - theft increases. An alarming stat came from Target, which said on the call that, “Threats and thefts involving violence at stores jumped 120% in the first five months of the year.” They then followed up by saying they expect to lose $1.3B due to theft in 2023.

But Target wasn’t alone in reporting this. The new buzzword that made headlines over the quarter was “shrink.” Just like AI was mentioned hundreds of times on tech company quarterly calls, retailers all spoke of shrink in the industry. Shrink (AKA theft) was listed as the main blow to profitability for sporting goods company Dick’s. On the earnings call, Dick’s CEO Navdeep Gupta said, “The biggest impact in terms of the surprise for Q2 primarily came from shrink. The number of incidents and the organised retail crime impact came in significantly higher than we anticipated. This has led the company to lower its full-year profit outlook.”

While “shrink” is not always accurately measured, it’s alarming to see the trend of theft doubling, as consumers get more desperate.

2. Financials 👉 Banks Lagging YTD

Frequent readers will recognize a phrase that I’ve written before: “As goes the economy, so goes the banks.” The same can be said for the relationship between consumers and financials. As go consumers, so goes the banks.

Banks have had a weak year, underperforming the S&P500 significantly. YTD, the XLF index is roughly flat vs. a 15% increase in the S&P, and a 31% increase in the NASDAQ.

Since the sell-off sparked by the collapse of SVB in March, financials have struggled to recover.

A higher rate environment is a double-edged sword for banks’ earnings. On the one hand, they earn higher net interest margins (NIMs), as the rate they are able to lend out at exceeds the rate they pay for deposits. On the other, a higher rate environment is typically synonymous with a weaker macroeconomic backdrop which translates into slowing loanbook growth.

A particularly hard-hit side of the bank’s business is mortgage loans. If we look at mortgage originations in the United States since the early 2000s, we can see that origination recently touched 2008 GFC lows:

Everyone took advantage of rock-bottom rates during the Covid cutting cycle and locked in long-term mortgages. As we know, most of these homeowners cannot afford to move, nor should they, as mortgage rates have reached highs not seen since the turn of the century:

The stock market is also a real-time, forward-looking pricing mechanism: it prices in expectations. With rates now up to restrictive levels, the market is starting to wonder how much better NIMs can get. At the same time, the consumer is getting weaker and housing is becoming less affordable.

3. Economic Data Dump 👉 JOLTs, Consumer Confidence, PCE, and NFP

Last week, we were also treated to a slew of new Economic Data: JOLTs, Consumer Confidence, PCE, and GDP.

JOLTs

On Tuesday, we got the JOLTs number, showing Job openings:

Job openings fell to 8.8M in July, below median expectations of 9.5M. Additionally, Quits dropped 253k to 3.5M with layoffs unchanged.

This job openings figure represents the lowest measure in 2.5 years, indicating a cooling labour market, which is encouraging for the Fed. While the trend is down, the labour market still remains historically tight, with 1.5 job openings for every unemployed person, well above the 1.0-1.2 range considered consistent with a jobs market that is not generating too much inflation.

Consumer Confidence

Also on Tuesday, we got the consumer confidence numbers:

The Confidence Board’s index fell to 106.1 from its prior reading of 114, and well below the median estimate of 116. A gauge of expected inflation a year ahead edged up to 5.8%, marking the first uptick in five months.

Consumers are still concerned with the impacts of inflation, particularly around groceries and gasoline. When it comes to the Fed, this is a “bad news is good news” indicator, in that it could lead to softening demand, driving cooler inflation.

PCE

On Thursday, we got Powell’s favourite inflation measure, PCE. The headline and core PCE indexes reaccelerated to 3.3% YoY (from 3%) and 4.2% (from 4.1%), respectively, in July.

Given the stubbornly high PCE, another Fed rate hike this fall is not off the table.

NFP

On Friday, we got nonfarm payrolls. Futures spiked higher on the jobs data ahead of the open. NFPs came in higher than expected, wage growth slowed and the unemployment rate surprised to the upside. July’s NFP number was also revised lower.

Wrapping Up…

It looks like the consumer is starting to show signs of weakening. So far, we’ve seen rates remain higher all due to the strength of the consumer as shown in unexpected growth. As consumer health deteriorates, will we see the Fed step in and cut rates?

Or will they hold firm in squashing inflation until we see even lower CPI/PCE figures?

Only time will tell…

Until next time. Always Yours. Incessantly Chasing ROI.

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