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Issue 33: Deep Dive on Consumer Spending

May 22, 2023

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Deep Dive on Consumer Spending

Picking apart last week’s retail sales data
We’ve often commented that investors really have one group to thank for a surprisingly robust US economy: the American consumer. For the last year, despite uncomfortably high inflation pushing up input costs and threatening companies’ margins, households’ unshakable propensity to spend has allowed firms to pass inflation off to their customers and keep profits going strong. In the last few months, however, data suggest that dynamic could be breaking down. Last Tuesday, the US Department of Commerce reported a bounce back in retail sales in April, with spending increasing 0.4% month-over-month on a seasonally adjusted basis, following consecutive declines in February and March. Unfortunately, that was only half the 0.8% climb economists had predicted, and isn’t adjusted for inflation, which itself was 0.4% in April. Digging into the data, the increase in sales was driven by purchases of cars, spending in restaurants, and online shopping (see below). Consumers cut back on big-ticket purchases—things like appliances and furniture—as high inflation and tight financial conditions finally seem to be forcing households into a more selective, price-conscious mindset.

Figure 1 April 2023 Retail Spending

Retailers’ earnings weigh on equity benchmarks
These macro results were also showing up on the micro level, as Q1 earnings continue to roll in. Home Depot released its results on Tuesday, as well, posting its biggest miss on sales in over two decades and guiding analysts down for the rest of the year on revenues. Walmart lifted investors spirits a bit on Thursday, beating forecasts and raising its outlook on the strength of its grocery and online sales. What should we make of these seemingly divergent results? Reporting by CNBC observed an interesting aspect of how these firms weigh in equity benchmarks. Home Depot’s price is almost double Walmart’s, despite being about three-quarters of its market capitalization, so the home improvement store plays a much bigger role in the price-weighted Dow index, while the Walton family’s massive stake in their firm also depresses its weight in the S&P 500. Thus, even if Walmart has a bigger economic footprint, Home Depot might make bigger waves in the market.


Household budgets are feeling the squeeze
Walmart’s earnings beat also reflects the trend toward belt-tightening for American households. Online sales, for example—shown as ‘nonstore retailers’ in the chart above, and a major part of Walmart’s business—helped to keep retail spending high in April, while bigger discretionary purchases slowed. And while Walmart reported solid results in their grocery segment, it’s a segment that’s feeling the pain more broadly, as inflation has pushed consumers to make tough choices. According to data from NielsenIQ, roughly 90% of consumers have scaled back on their grocery budget, only buying what they absolutely need in the face of rising prices. To be sure, savings remain elevated and we’re only seeing a gentle slowing in consumption from a very high level; we might consider these developments as something like a hairline fracture in the foundation of consumer spending. Nevertheless, with consumer spending serving as the primary driver of US economic growth, at around 60% of the country’s GDP, such trends are worth watching closely.


As top earners take a hit, spending will suffer
Of course, financial analysts have been forecasting weak consumption in response to higher prices for some time now, and the tight labor market combined with steady wage growth have thwarted those predictions. That said, even within the remarkably robust US labor market, cracks are emerging. In April, for example, nonfarm payrolls increased by just 253,000 jobs, down from the 2022 monthly average of 400,000. Similarly, the latest initial jobless claims data shows a slight increase to 239,000 on a four-week average basis, compared to an average of 214,000 in 2022. The final tally of job openings in March, while still relatively high, fell 20% from its peak a year ago. Importantly, the experience has varied across income groups. Data from Bank of America show higher-income households have been hit harder, with unemployment benefit claims in this group increasing by over 40% YoY in April, five times the increase among lower-income households. This trend is also reflected in wage and salary data, as higher-income households saw after-tax wages contract by 1.3% YoY in April on a three-month rolling basis, the second consecutive month of negative growth. These trends are driving divergence in spending patterns across different income groups, with higher-income households spending less in April compared to a year ago. This is significant, as the highest 40% of households by income account for over 60% of overall consumer spending (see below), such that a labor market slowdown in this segment could have a considerable impact on the overall economy.

Table 1 Share of Total Annual Consumer Expenditure

Brief Update on the Housing Market

Breaking down April’s housing market stats
Last Tuesday the US residential real estate market got a bit of good news, with Commerce Department data showing housing starts increased 2.2% in April, versus economists’ forecast of a decline—though were still down over 22% from a year prior, as persistent inflation, aggressive Fed tightening, and the prospect of a recession have taken a toll on homebuyers and builders. Breaking the numbers down further, multi-family continues to be a bright spot, with new construction in that segment up 5.2%; single-family starts saw a more moderate increase of 1.6%, but reached their highest level this year on a surge of activity in the Western region. By contrast, building permit authorizations, considered more of a leading indicator, pointed in the opposite direction, with overall approvals declining by 1.5%, though permits authorized for single-family homes rose by 3.1% to a seven-month high. Building completions were down across the board in April. Overall, the picture painted by recent data is of a US housing market showing modest signs of improvement, but still decidedly in a slump.


Tight supply pushes single-family sentiment higher
Data on single-family homes is consistent with April’s release of the National Association of Home Builders / Wells Fargo Housing Market Index, also published last Tuesday, which measures sentiment in the single-family housing market. The index rose from 45 to 50 in April, the first time in almost a year that the indicator wasn’t below 50—a level representing neutral sentiment—and the fifth consecutive monthly increase. The index hit a 35-year high of 90 amidst a surge of pandemic-era homebuying in November 2020, and still stood at 83 at the start of last year, before a barrage of Fed rate hikes to tame inflation put a damper on activity in the highly rate-sensitive housing market. What’s driving the recent resurgence in sentiment? As we’ve pointed out in past Perspectives, many current homeowners locked in super-low rates over the past few years and aren’t inclined to sell, limiting the supply of existing homes and sending homebuyers to the market for new homes: demand that builders will happily meet with new construction. Indeed, inventory is down 40% compared to 2019, and this scarcity of available homes has led to a meaningful increase in housing prices and intensified competition among buyers. This trend naturally benefits existing homeowners, supporting prices against a gloomy macro backdrop, but builders are also capitalizing, offering financing incentives to improve affordability and generate activity despite painfully high mortgage rates. The stock market has also apparently noticed tight supply and is looking ahead to easing borrowing costs, with homebuilders’ shares currently trading at ten-month highs (see below).

Figure 2 US Homebuilder Stocks vs S&P 500