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Good morning. Any market excitement about the (putative) resolution of the debt ceiling showdown was short lived. US stocks opened strong yesterday and faded to flat. Bond yields fell a bit all across the curve. Is this because the market doesn’t care about the deal, or doesn’t believe it solves anything? Email me: firstname.lastname@example.org.
The low-end theory
Last week I acted as a panel moderator at the FT Business of Luxury Summit in Monaco. It was a lot of fun. The big takeaway is that the luxury industry globally is absolutely killing it right now. I’m a fan of the sector; after all, the Hyde to my Jekyll writes about clothes. But (as I argue here) the hyper-prosperity of companies catering to the rich is only partly good news for the economy. The inequality that feeds the luxury boom is probably a drag on overall growth.
As if to prove my point, while I was hobnobbing with couturiers on the sunny Mediterranean, several companies that live in the other half of the economic spectrum — dollar stores and warehouse clubs — reported results. They had a less upbeat story to tell.
Dollar Tree reported a big shift away from durable goods to food, which severely crimped margins. The shares fell 15 per cent on the news. Here’s chief executive Rick Dreiling speaking to analysts:
The consumer continues to be under pressure. There are simply fewer dollars available to them, and those dollars are not going as far as they did a year or two ago. We are past the multiple rounds of government stimulus. Snap [food stamp] dollars have been reduced and tax refunds are running lower. These impacts, combined with persistent inflation, have more families prioritising needs over wants
Earnings from BJ’s Wholesale also triggered a sell-off in the stock, and the pattern was similar, with some important differences. Chief executive Bob Eddy said:
Our food and sundries businesses remained robust with comp sales up 8 per cent . . . more than half of our merchandise comps were driven by growth in traffic . . . we are pleased to have grown market share across our core business in the first quarter . . . consumers remain selective in their shopping behaviour and members are more conscious as they continue to work to stretch their dollars . . . as a result, our general merchandise and services comp was down 8 per cent year over year
More people are shopping at warehouse clubs, which are taking share from higher-price-per-unit grocers. But they are there for food in bulk, not big-screen TVs. At Costco, chief financial officer Richard Galanti noted that customers are switching from beef to pork, and from brand names to store brands:
Not just in this current “recession” or concern for recession, [but] historically, within fresh protein, we’ve always seen when there’s a recession, whether it was ‘99 or ‘00 or ‘08, ‘09, ‘10, we would see some sales penetration shift from beef to poultry and pork. We have seen some of that now . . . I think last quarter, I mentioned that on a year-over-year basis, there’s a 150 basis point increase in private label sales penetration. And this year, at the end of the quarter, it’s [another] 120 basis points.
I’ve rattled on about this several times now. Hopefully the picture becomes sharper with each iteration. The US consumer in aggregate remains a strong spender, and is absorbing price increases with little complaint. But as one looks across the discount spectrum — at the big box stores, warehouse clubs and dollar stores — it becomes increasingly clear that lower-income consumers are under pressure and are changing their spending habits meaningfully. This is pinching the margins of discount retailers and staples companies generally, and those stocks are not performing well, as the chart above shows. Of the 37 consumer staples stocks in the S&P 500, all but five have fallen over the past month — and most of them have fallen significantly.
Having established that lower-end consumers are under increasing stress, the next question is where this stress will show up next and how investors can respond. One might argue that the struggles of these consumers represent a warning sign for the wider economy, but I’m not sure that is the case. Perhaps the economy can chug along even as the bottom quintile’s struggles increase; I hope that’s not so, but it may be.
Where will the stress appear next? The natural place to look, it seems to me, is auto loans. Almost everyone in America needs a car to get to work, almost everyone finances their car purchases, and auto loan rates have been rising sharply. We have good data on this through the end of the first quarter, from the New York Fed Household Debt report. Here is its chart of transition into 90-day delinquency for auto loans, segmented by age:
The trend among younger borrowers is really very bad. For those under 30, delinquency transitions have passed their pre-coronavirus levels and are approaching the peaks of the financial crisis. For those between 30 and 40, the picture isn’t much better. And it seems unlikely, given what we have heard from the retailers, that things have gotten better since March.
The hardened cynics among Unhedged’s readership — a majority, I assume — will be wondering how to play the weakness at the lower end of the consumer economy. I’m not sure I have a good answer. A fair amount of margin contraction already seems priced into staples stocks (and a big premium is baked into luxury stocks such as LVMH). Shares in pure play subprime auto lender Credit Acceptance did take a punch when they reported soft credit trends in loans made in the past several years, and the pressure could increase from here. But at 13 times earnings, that stock is not priced for a boom.
This much is clear, at least: it no longer makes much sense to think about investment strategy in terms of “the American consumer”. There is an increasing bifurcation among income groups that must be kept in mind. Is it a surprise that, as worries about a recession have taken hold this year, consumer staples underperformed consumer discretionary? In a split world, it makes solid sense.
One good read
Ron DeSantis thinks policy matters in the primaries, which is just adorable.
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