Shifts in Spending: Insights on the Current Consumer Landscape

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Stacie Jacobsen: Thanks for joining us today on The Pulse by Bernstein, where we bring you insights on the economy, global markets, and all the complexities of wealth management. I’m your host, Stacie Jacobsen.

On today’s episode, we’re talking about consumer spending. The strength of consumer spending, which represents around 70 percent of GDP, has been a surprising source of resilience in the US economy. But we’re starting to see signs of strain on the lower income end and delinquency rates have ticked up, you know, really relative to recent history.

But the good news is consumer fundamentals remain strong and consumer confidence is increasing. However, the bigger story may be in this shift in how consumers are spending. Our guest today, Snezhana Otto, is here to help us make sense of these trends. She’s a senior research analyst and covers US Large cap consumer discretionary and health care equities.

Snezhana, welcome back to The Pulse.

Snezhana Otto: Great to be back on the show. Thanks for having me.

Stacie Jacobsen: So, to get started, consumer spending is holding up better than we expected coming into the year. Why is that?

Snezhana Otto: I think there’s quite a bit of a narrative around consumer sentiment being pretty depressed and we actually see that that in the numbers as well, right?

Things like the University of Michigan Sentiment Gauge are still low, albeit improving, but, that actual data points on total aggregate consumer spending are holding up pretty nicely. Even this morning, and we’re recording on the 17th of September, this morning, retail sales were released for August, and those were really stable month on month and increasing a good sort of solid three and a half percent year on year.

So, in total, consumers are spending, they’re spending more than they did last year. The increase in spending year on year is pretty big. Pretty close to what normal trend looks like. And to the extent that actors in the economy that have a sort of broad view on consumer spending, whether it’s the banks that my colleague covers, that’s been pretty stable, the credit card companies that see sort of the monthly switching volume, they’re talking about stability, broad based retailers in my coverage, like Walmart that sell to a broad swath of consumers and sell them a broad basket of goods they’re talking about stability. stability month on month.

So pretty consistent message on that total overall amount of spending by the consumer. Why is consumer spending holding up is an interesting question, um, and when you look at sort of the underlying drivers, so unemployment is actually pretty steady, yes, it’s steadily ticked up, but lots of kind of conflicting and noisy data points there to the extent it’s ticked up.

There’s also been some increase in the supply of labor. So, it’s still a pretty low absolute number in the low fours, right? Nominal income is still growing at kind of trend four to five percent rates for the higher end of the income spectrum, to the extent people have savings either invested in the stock market, which has been doing pretty well, or are invested in their homes.

Home equity has been doing pretty well as, as home prices have continued to rise. And in terms of kind of more across the income spectrum, sort of things that on a year-on-year basis can create some noise in people’s propensity to spend on the lower end, things like gas prices, SNAP benefit changes, things like that, they’re actually pretty stable year on year after some kind of big COVID years.

Stacie Jacobsen: Snezhana, we are seeing that even though consumers are still spending, there’s this shift, right? They’re becoming much more price conscious. So, can you share your perspective on the concept of “trading down”?

Snezhana Otto: Absolutely. So, “trading down” isn’t a new concept. We just sort of temporarily forgot about it during the pandemic when everyone had a little bit more excess savings and was a little bit more price conscious, right? In my retail universe, “value winning” was a theme that had been going on for a while prior to COVID.

Hence the success off-price retailers, for example, the likes of TJ Maxx and Ross stores had been taking market share from your standard department stores for a while. And in some ways, what we’re seeing now is just a reversion to that secular long-term trend. And you’re certainly seeing the off-pricers that I mentioned,they’re reporting same store sales growth in the mid-single digit range, which is quite healthy and well above other higher price point retailers.

Similarly, you’re seeing Walmart gaining a lot of share and talking about seeing “trade down” customers, walking into their stores from across the income spectrum.

You’re seeing restaurants talk about the importance of value and the fact that to start the year, fast food restaurants were losing traffic, because they were lagging behind on the value perception, you’re seeing luxury and accessible luxury brands, which did remarkably well during the pandemic, although that was a surprise at the time, who knew that people needed more handbags in their closet when they couldn’t get out, right?

But it was probably related to this kind of price insensitivity and people feeling a little more flush, that’s definitely taking a step back right now. So, lots of manifestations of people looking for value again.

Stacie Jacobsen: All right. And if we continue kind of splicing the overall consumer spending number, right, there’s been a shift between goods and services as well.

Snezhana Otto: Absolutely. And that was obviously very, very abrupt in the depths of the pandemic, as all of us could only really spend on goods. And that reversion back to long term trends has had a couple of years to happen. But at this point, good spending is still growing a little bit less than normal and services spending is still growing a little more than normal and aggregate as those trends fully work themselves out and obviously goods is also the part of our spending that gets impacted by the current high interest rates environment.

So, things like home related spending, things you might want to finance with a home equity loan, anything really that requires financing a new car, right? All of that happens to be in the goods category. So, it’s a little bit of a double whammy for goods relative to services still, but getting better incrementally.

Stacie Jacobsen: How are retailers responding to the shift in consumer spending?

Snezhana Otto: Yeah. So, to the extent that these trends have now become pretty obvious and they all want to position themselves well for them, you’ll have For example, Walmart over the last few years has lost the market share on the general merchandise side.

So, they’ve done a lot to upgrade their general merchandise apparel home offering to keep those customers engaged and get them shopping across more aisles. They’re also trying to meet all of those customers. They’ll say where those customers are, whereas in the past, they’ve talked about how back in 2009, they also got the “trade down” effect, but didn’t get to keep it coming out of the recession because the Walmart shopping experience just wasn’t that convenient. You have to walk through a giant parking lot, right?

They’ve done a lot to try to make the in-store shopping experience better, but also to upgrade the eCommerce shopping experience. There’s a lot more delivery to home, it’s much faster, and so they’re hoping that coming out of this “trade down” experience, they actually get to keep these consumers because they’re offering them such a more convenient experience than what they might have expected.

You’ve got, not retailers, but the restaurants like McDonald’s who saw slowing traffic at the beginning of the year across the industry, because there had been a number of headlines in the news around how particular restaurants seem to have raised prices very, very significantly versus 2019 and consumers were starting to notice.

And part of this dynamic was simply a timing dynamic. Restaurants actually didn’t take as much price increases early in the pandemic as grocery did, but then they more than caught up. And so, relative to what consumers remember from pricing last year, grocery prices seem to not be going up as much anymore, but restaurant prices are still going up.

And McDonald’s seemed to be at the center of this particular media storm. So, they’ve done a lot to try to mitigate that, so, I think their CEO put out a letter sort of trying to set the facts straight on just how much they’ve raised prices and that it’s in fact not been ahead of inflation, and they’ve launched a nationwide  five dollar meal that includes a drink, fries and a sandwich to sort of fix the value perception and get customers to view them as good value again.

Stacie Jacobsen: Okay. So, what else are you keeping your eye on when you actually are breaking down the consumer spending number?

Snezhana Otto: Yeah. So, consumables versus more discretionary purchases is getting talked about a lot by the different retailers I look at, and part of that is related to what we’ve been seeing with inflation trends. So overall inflation we all know was excessive but has been moderating. However, within that, a lot of the non-discretionary part of people’s wallets has actually inflated by more than their incomes and the overall inflation rates.

So, grocery inflation we know has been in the headlines on a cumulative basis. It’s a little over 25 percent, which is more than overall inflation, which is running closer to 20 percent energy prices, auto payments, mortgage payments, car and home insurance. Things you can’t avoid spending money on have all inflated a little more than the general level of inflation.

And that just means there’s less wallet chair left to spend on those discretionary items. So, for the more pressured lower income consumer that has meant more tradeoffs in how they spend their available income.

Stacie Jacobsen: When you think about the lower income delinquencies, how does that permeate the rest of the economy? Is that a number that we really need to worry about?

Snezhana Otto: Yeah, I think we want to look at data points like that in context, and so, the delinquency rates are a valid data point, but for now they seem to be a little concentrated in auto loan segment. And there’s some very specific things going on there related to just how much auto prices have inflated. If we start seeing them become more widespread, that would be a problem.

The reason they matter for spending is even though lower income consumers are a smaller share of total spending, uh, they have a higher propensity to spend every incremental dollar. And so, it does matter, but it would really start to worry me if we started to see it become more widespread. And again, so far, it really hasn’t been an impediment to any of the retailers that I look at in terms of their overall sales.

Stacie Jacobsen: Okay. What are you seeing on the higher end of the income spectrum?

Snezhana Otto: Yeah, the data points there are a little more conflicting. In general, it seems to be holding up better, but there have been some signs of weakness. We’ve had a few data points of retailers starting to talk about the middle-income consumer starting to be, they like using the word more “choiceful” in how they spend their money.

We’ve had, uh, some examples of goods that are geared towards the higher income consumer. So, for example, big home improvement projects that Home Depot and Lowe’s sell into, kind of luxury items that European luxury brands sell, those have seen weakness as well, right? So, even at the higher end, people have become, uh, a little more value conscious and a little more discerning in terms of how they spend.

Stacie Jacobsen: The other piece to this is not just wage growth, but savings, right? And so, when you think about the consumer, what did the savings rates look like these days?

Snezhana Otto: Yeah. So, savings rates are still pretty low, but how much people have in their bank accounts is still a little bit above where they started out pre-pandemic; that shot up a lot during the pandemic when people were stuck at home and couldn’t spend and at the same time, in some cases, we’re getting a windfall of government transfers that has largely been drawn down, but not below levels that people had in 2019.

So, uh, across the income spectrum, people seem to have at least as much in their bank accounts as they did, uh, uh, kind of going into the pandemic.

Stacie Jacobsen: Okay. And so how much does that impact what they’re feeling comfortable to spend?

Snezhana Otto: I think the best thing that we can observe is sort of that phenomenon that we talked about earlier with people becoming more value sensitive. So, a couple of years ago when everyone had a significant cushion in their bank accounts way above what was normal, the price sensitivity was pretty low.

And now that most of that cushion has been spent through, especially at the lower ends of the income spectrum, people have become price conscious again. And that’s sort of the behavioral manifestation.

Stacie Jacobsen: What about in the experience economy, right? So, you know, there’s stories of people who spent their summers traveling or going to high ticket concerts.

Do you see that changing in the relatively near future?

Snezhana Otto: There have been changes and lots of debates about the stocks in that travel space, because again, over the last couple of years, they’ve been the beneficiaries of people going back to spending on services and last year was the summer of revenge travel.

So there have been some incrementally weakening data points. Again, the market likes to focus on the very last data point. So, for example, in hotels, kind of the leisure data points have been a little bit weaker recently. On the other hand, to the extent there are cheaper forms of travel, so, for example, cruise is viewed as sort of a value “trade down” option because it’s typically 10 to 15 percent cheaper than going on a comparable land-based vacation, the cruise line companies these days claim it’s more like 25 percent due to the inflation gap that’s opened up during COVID. So, they are still doing really, really well, maybe because they’re benefiting from people still want to do some travel, but there too are choosing to trade down and go for value where they can.

Stacie Jacobsen: All right. Now I’m based out of our Los Angeles office and in California, you may know that, especially on the fast-food restaurant, there’s been a minimum wage increase. Are you actually seeing that impact earnings across the country? Or is that just really isolated to the environment that I’m in?

Snezhana Otto: So somewhat, so the restaurants that are more exposed to California have definitely talked to it.

Even the ones that have a very broad footprint, like the McDonald’s of the world, when they’ve guided to this year’s wage inflation that they’re expecting to experience, they’re sort of saying it’ll be, you know, kind of four percent plus. And part of that is driven by the very significant increase in California.

I think the takeaway so far has been that in California, it has led to higher restaurant prices, and as a result, it has impacted consumer traffic because again, people are value conscious across the country and seeing prices rise is not the best way to bring them in right now.

Stacie Jacobsen: You know, you had, you had mentioned the stocks related to higher-end travel, so that leads me to think about the market in general. So, what is the market assuming consumers are going to do from a spending perspective?

Snezhana Otto: Yeah, the market’s been acting very Jekyll and Hyde on this theme and it’s really been whiplash by expectations around what the Fed is going to do in terms of interest rate cuts and in terms of expectations around whether or not we get a soft landing.

There have been some very violent moves. In the entire consumer-related sector overall, as those expectations have shifted over the last few months, and then within each subsector, there’s actually been a good amount of divergence between the relative winners and losers because despite these big shifts that we talk about, sort of the micro still matters, and there are even within each of these subcategories, there are relative share gainers and losers, and some of the share losers have been penalized pretty badly in the market recently.

Stacie Jacobsen: So far throughout the conversation, your outlook feels relatively positive, right? So, what is it that could knock the consumer spending off? Is there a canary in the coal mine that you’re keeping an eye on?

Snezhana Otto: Well, first of all, whatever happens with, um, Fed interest rate decisions tomorrow, you our listener will know by the time you listen to us, that could sway things because to the extent we get interest rate cuts flowing through, especially the good side of the economy, the housing related, uh, spending in an environment that is otherwise still pretty steady.

So, some sort of soft-landing scenario, we could see a nice re-acceleration of those types of spending. Otherwise, I’m just watching the same things that we talked about in the beginning that are sustaining that overall spending level, right? Is there a big change in unemployment, the stock market, and housing prices, which have been sustaining that wealth effect?

Does that start to wobble? Those would be the big things I’m watching.

Stacie Jacobsen: All right. And as we’re entering year end, there’s really two big events, right? So, one is the holiday shopping season and the other is the election. How do consumers spend through those two events?

Snezhana Otto: The very early data point that we have on this is what retailers have been saying about how back-to-school season has been going, so far at a series of recent conferences, for example, and those that have reported earnings have tended to talk about back-to-school season going relatively well, okay, especially relative to these subdued expectations that we all seem to have that tends to be a, uh, a reasonable first read on how consumers might spend over the holiday season. However, this year, there’s a few potential concerns to look out for holiday.

One is the holiday calendar is not very advantageous to consumer spending. It’s shorter. And then the other pieces, most retailers talk about elections in the past as having been a little bit disruptive to consumer spending because people just kind of get distracted and don’t spend as much. So those are the two things that might throw a little bit of a wrench to what otherwise so far seems like steady Eddie consumer spending.

Stacie Jacobsen: So, it doesn’t seem to be the outcome of the election, it’s more the fact that there is an election and consumers are being distracted.

Snezhana Otto: Yes, that seems to be what history would suggest.

Stacie Jacobsen: What parting thoughts would you like to leave our listeners with?

Snezhana Otto: Yeah, there’s been a remarkable amount of volatility in consumer spending over the last few years because there’s been a lot of volatility in people’s day-to-day lives and behaviors and deviations from kind of long-term trends, but many of those are starting to normalize and to the extent that people’s total income and wealth, it doesn’t take a very significant turn for the better or worse. It’s been pretty steady year to date, which has been quite surprising if you listen and read the day-to-day headlines, which have been pretty volatile.

So that’s been the surprising, but also, I guess, optimistic thing about how consumer spending has been developing so far this year.

Stacie Jacobsen: Thank you so much, Snezhana, for being with us today and I hope to have you back again soon. And thanks to our listeners for joining us today. We’ll be back in two weeks with another episode.

I’m your host, Stacie Jacobsen, wishing you a great rest of the week.