American Consumers: Resilient in Their Spending
What’s surprised most economists this year hasn’t been the magnitude and direction of rate cuts, but rather the resilience of the American consumer. Spending has continued to be robust, despite elevated rates pressuring pocketbooks. We believe consumer spending will continue, even though credit card debt levels have risen and excess Covid era savings appear to be spent.
In fact, we believe there’s a possibility consumer spending could surprise to the upside. Wealthier Americans with lower debt-to-income ratios are positioned well to sustain or increase their spending patterns. This group is responsible for a majority of American discretionary spending. Furthermore, while lower-income households face some stress right now, their financial conditions are poised to loosen as rates come down and inflation comes under control. If the outlook on the consumer starts to shift, we could see consumer discretionary names start to become investment opportunities. In particular we would point to retail businesses who have spent time building brand loyalty and catering to evolving consumer preferences. Over time these discretionary business models can become American staples.
Assessing the Health of Consumers
The first thing most people look at when talking about consumer health is credit card balances. Credit card debt in the U.S. reached $1.14 trillion in Q2 2024, a record high. However, while credit card balances are at all-time highs, it’s important to note that consumer debt service payments, excluding mortgages, make up 5.6% of disposable income – a number that’s in line with historical averages. If consumer debt grows in-line with GDP and incomes, then the all-time highs are a natural by-product of our nation’s record-setting growth coming out of the pandemic. Record high credit card debts are okay if they’re growing in line with the rest of the economy and debt service costs are manageable.
Also worth noting is the composition of spending. While lower-income households carry a much higher credit card balance relative to their income, wealthier Americans are generally the primary driver of consumer spending. This groups ability to spend remains relatively healthy. High income households have seen a 17% increase in inflation adjusted retail spending since 2018. This is important because the top income quintile makes up 40% of personal consumption, and personal consumption makes up approximately 60% of domestic GDP.
Lower income households are under more pressure. Their spending has still risen since 2018, middle income up 13.3% and lower income by 7.9%, but the spending growth lags that of their wealthier peers. This group is burdened by relatively heavier debt loads and are more exposed to inflationary pressures. Price increases have eroded their purchasing power, and rate hikes have hampered these groups’ access to credit. However, these groups are starting to see some light at the end of the tunnel. Inflation appears to be moderating, with core CPE at 2.7% in September. Wage growth is also moderating, but not as quickly. Real wage growth was back in positive territory in September, clocking in at 1.8%. Furthermore, positive wage growth was especially strong for moderate wage earners. Finally, with inflation abating the Fed can finally start to reduce interest rates, bringing a degree of debt relief to millions of Americans carrying credit card balances or other adjustable rate debts.
So, What’s Next For The American Consumer?
The American consumer has been under stress, but it’s not like they stopped spending completely. We believe brands that have tried to work with the stressed consumer through this recent period of instability stand to benefit significantly as the tide for the consumer begins to turn.
Think about a company like McDonald’s (MCD) – to attract customers wanting a better deal eating out, they’ve had to rely extensively on promotional offers. These promotional offers aren’t big profit engines, but the traffic during hard times helps build brand familiarity and form habits. When times are better and consumers can afford more, McDonald’s benefits from having expanded their consumer base. This kind of growth in bad times sets up the company for success when the economy is expanding. Companies like McDonalds are also trying to innovate to cement their position in a consumer’s lives by rolling out loyalty rewards programs and gamified applications. Businesses are willing to offer discounts or promotions through their apps because it helps build consumer habits and the data the businesses can get back about app usage gives them valuable information about which discounts or promotions are effective. Building habits and establishing a consistent customer base is key for helping companies sell more product, expand into new markets, and overcome disruptions to their consumer base or to their business model.
Providing the customer with value and consistency also sometimes requires simplicity. Focused marketing and a simple product can be a really effective way to build brand loyalty. Take Chipotle (CMG) and Starbucks (SBUX) for example – CEO Brian Niccol took the reins of the global coffee chain in September and has preached simplicity. A simpler and cheaper menu. An app that’s easier to navigate. A reversion back to being the neighborhood coffee shop. It’s just a simple focus on coffee! Before Starbucks, Niccol took Chipotle’s stock to all-time highs with its cost-efficient and customizable menu – all while limiting the complexity of actually making a burrito. Minimalism kept internal costs down and allowed the company to offer a better product at a better price. Keeping it simple and consistent can help consumers feel like they’re not splurging on lunch or their morning coffee and can lead to recession-proof earnings for the underlying businesses.
Positioning yourself as a value option with a simple business model can also work outside of the food and beverage space. Look at apparel retailers. They have also benefited from a shift to preferences for value amid rising costs, especially among Gen Z and millennial shoppers. Retail stores where consumers can “trade down” are essential to maintaining consumer spending when times get tough. Think about companies like TJX Companies (TJX) and Burlington (BURL) – clothing retailers who have been taking market share from department stores for years and continue to look more like consumer staples rather than being discretionary names. Retail isn’t even close to dead here, as shoppers can still pick out branded items but at a steep discount.
Where American’s aren’t opting for cost savings, they are opting for convenience. Think about mini splurges like ordering take out. DoorDash Inc (DASH) has continued to see robust growth among its users even as the broader economy has faced spending challenges. There are two angles to the success. First, on the consumer side, food delivery apps are becoming normalized. It’s becoming habitual, just like a morning stop at the local coffee shop. This habit building starts with meal orders, but the opportunity set for companies in the space is much wider. They’re solving last mile logistics for everything from meals to groceries to pharmaceutical goods to packages. Second, on the worker side of the equation, the gig-economy gives people another way to earn a bit of money to fund their habits. It doesn’t have the commitment of a second job and it’s flexible, but still gives people an easy way to earn money when times would otherwise be tough.
Finally, it’s important to be cognizant of how broad the consumer space is. Not every company that has a consumer facing arm is necessarily dependent on the consumer for its growth. A prime example of this would be a company like Amazon (AMZN). Amazon is a huge consumer shopping platform so it gets categorized as a consumer discretionary type of name. But someone like Amazon also has other divisions. In particular, Amazon’s AWS division is one of the largest hyperscale cloud providers in the world and consistently generates a substantial portion of the company’s operating income – a far cry from being a simple consumer oriented e-commerce business. On the other hand, a company like an American Express or Visa get classified as financials, but they still depend on consumer spending and on brand loyalty to make money.
Final Thoughts
We think businesses offering discounts to Americans burdened by higher inflation and interest expenses are likely to keep building loyalty among their customers. Building loyalty now should pay off in the future when the consumer’s financial situation begins to improve. Furthermore, businesses need to streamline and adapt to new consumer preferences for value and convenience. Investors should keep a close eye on businesses with the potential to break away from dependency on the economic cycle and which assert themselves as American staples.