Consumers Shift From Spending To Saving - Adjust Your Investment Strategy
The strength of the American consumer is a crucial pillar of the US economy. As the primary driver of economic growth, consumer spending influences everything from corporate profits to employment rates.
Recently, concerns have emerged about weakening consumer strength, raising questions about the broader economic implications and how investors can navigate these turbulent times.
This article explores the trends indicating a decline in consumer strength, the economic consequences, and investment strategies to mitigate associated risks.
Understanding Consumer Strength and Its Economic Importance
Consumer strength refers to the overall financial health and spending power of households. Essentially, it highlights how comfortably consumers spend on discretionary items.
Robust consumer strength fuels economic growth by driving demand for goods and services, leading to higher corporate revenues and job creation. Conversely, weakening consumer strength can signal economic trouble, as reduced spending impacts businesses and, by extension, the broader economy.
Understanding where consumers stand is crucial in determining the short-term outlook for the entire economy. We will start by analyzing the key metrics signaling consumer strength.
Key Trends Indicate Weakening Consumer Strength
Americans Have Spent Their Excess Cash from the Pandemic
During the pandemic, many households accumulated excess cash due to government stimulus checks and reduced spending opportunities. However, this surge in savings is now diminishing as people deplete their funds.
Recent data, published by the Bureau of Economic Analysis and highlighted by The Kobeissi Letter, suggests that Americans have spent all the excess savings they accumulated during the pandemic period.
Saving and spending is a cycle. People saved money during the pandemic and spent it right after. Now, they may need to start saving again. This indicates that the temporary boost to consumer spending may be fading.
We might see a decline in consumer strength as households have less disposable income to sustain spending.
Wage Growth Is Not Keeping Up With Inflation
Real wage growth, adjusted for inflation, is a critical measure of consumer purchasing power. It shows if salary growth has grown in line with inflation, or if the purchasing ability of this salary has declined.
Below, you’ll find the inflation-adjusted median weekly earnings of wage and salary workers from the US Bureau of Labor Statistics.
The chart highlights that with stimulus packages and quantitative easing policies, real wages surged in 2020. However, although nominal wages increased in recent years, inflation has eroded these gains, leaving many workers with stagnant or declining real wages.
Bureau of Labor Statistics data shows that real wages have not kept pace with rising living costs, and the purchasing power of the median earnings is back at pre-pandemic levels.
Consumer Confidence Index Shows Declining Sentiment
The Consumer Confidence Index, published by the Conference Board, measures the overall sentiment of consumers regarding their financial situation and the economy.
The index is set to 100 in 1985, and calculated based on the difference from the previous period.
The chart clearly shows that the pandemic was a huge shock to consumers, but they have recovered thanks to stimulus checks and quantitative easing policies.
However, recent trends indicate a decline in consumer confidence, reflecting growing concerns about inflation, job security, and economic uncertainty.
A lower confidence index suggests that consumers may be less willing to spend, further weakening economic activity.
Rising Consumer Delinquencies Signal Financial Strain
Rising consumer delinquencies on loans and credit cards are another worrying trend.
Data from the Board of Governors of the Federal Reserve System shows that the delinquency rate declined significantly with the quantitative easing policies after the pandemic.
However, we have been seeing delinquencies surge since 2022 with high interest rates and tighter conditions, signaling that more households are struggling to meet their debt obligations.
Higher delinquency rates can lead to tighter credit conditions, reducing consumers' ability to borrow and spend.
Savings Rate
The personal savings rate refers to the percentage of disposable income that consumers retain. The US Bureau of Economic Analysis releases this data monthly, providing insight into financial stability.
The chart shows the personal saving rate from 2017 until now. We are seeing a very similar trend to what we have seen with previous charts. This rate surged significantly during the pandemic as consumers struggled to find areas to spend on and benefited from stimulus packages.
More recently, personal savings declined to levels lower than the pre-pandemic levels with a higher cost of living, higher interest on loans, and lower real wages.
Consumers now have less financial cushion to absorb economic shocks, further weakening their spending power.
Economic Implications of Weakening Consumer Strength
Based on the insights above, we conclude that consumer strength is significantly lower than two years ago, and this declining trend is likely to continue.
It is crucial to understand the economic implications of this. Let’s take a look at what we see and expect one by one.
Consumers Are Getting Cautious Spending
A weakening consumer tries to spend less, especially on discretionary products. This behavior shift also has an impact on staple products that are seen as essential, as consumers trade down.
The recent McKinsey report shows that 76% of respondents have traded down within the past 3 months. They do it either by buying fewer products, chasing discounts, delaying purchases, or changing to a cheaper brand.
This reduction in demand affects various sectors, particularly those heavily reliant on consumer spending. This also directly impacts GDP growth, as consumer expenditures account for a significant portion of economic activity.
Companies Invest and Grow Less Due To Reduced Consumer Spending
Additionally, lower spending directly affects corporate strategies.
Companies exposed to consumer spending might invest less back into their businesses due to lower sales and revenue. This decrease in corporate investment can stifle growth and innovation, leading to slower overall economic progress. As companies pull back on expansion plans, the broader economy feels the ripple effects, resulting in a more pronounced slowdown.
Moreover, as companies struggle to maintain their revenue and profit targets, they may adopt cost-cutting measures such as layoffs, contributing to higher unemployment rates. This, in turn, reduces household income and further decreases consumer spending, creating a vicious cycle of economic decline.
Consumer Spending, Inflation, and Interest Rates
Consumer spending, inflation, and interest rates are all interconnected. When the economy is hot and consumers are spending, inflation is likely to increase. The Fed hikes rates to battle inflation and expects that consumers will spend less. When the Fed sees that the economy is slowing down, it typically cuts rates.
Historically, most recessions have occurred when the Fed started to cut interest rates following aggressive hikes. Find the federal funds effective rate chart below. The shaded areas indicate US recessions.
If consumer strength continues to weaken, and the economy slows down significantly, the Fed might lower rates to stimulate growth, potentially triggering a recession.
Investment Strategies to Mitigate Risks in a Weakening Consumer-Driven Economy
Defensive Stocks Are Not The Ones You Think
The stock markets are not unapproachable when consumers get weaker. In fact, there are still many opportunities. But we need to fix this misconception: staples do not necessarily perform well during a recession. Although these products are essential, the customer can still choose to buy the cheaper alternative or buy fewer. The McKinsey research shows that consumers are trading down. This includes staples.
Utilities is another sector that investors see as defensive. Although there might be some industries within utilities that perform well regardless of what consumers do, some are quite susceptible to consumer behavior. If people decide to cut their bills, they may try to drive less and use power and water cautiously. The utilities sector that provides the infrastructure for these would definitely be affected.
On the other hand, healthcare seems to deserve its defensive title. In particular, companies providing healthcare services that are covered under health insurance would be less affected by consumers’ ability to spend, as long as these consumers are insured.
While this sounds counterintuitive, some of the big technology firms may be more resilient than they seem. Companies like Apple (AAPL) and Amazon (AMZN) might be affected more by declining consumer spending, but companies like Nvidia (NVDA), which mostly sell to businesses with strong balance sheets, would be impacted less. This may be one of the reasons the stock has been going up.
In addition, it is important to understand the areas that are seeing high investment, such as aerospace and defense. It seems like we may have a good replacement cycle after all the problems with Boeing planes, and the increasing number of global conflicts suggests that governments will continue to spend on their military capabilities.
Whatever stock the portfolio includes, diversification remains key to being protected.
There May Be Opportunities In The Bond Market
While stocks of consumer-exposed companies may decline with lower earnings expectations, bonds do not have to perform similarly.
Fixed-income investors care about one thing only: getting their money back. If a consumer electronics company that will potentially see declining sales in a recession has a solid balance sheet, the company’s bonds may be safer than its stock.
Investors may benefit from the pessimism in financial markets as these companies struggle and buy bonds at lower prices.
Alternative Investments May Provide A Safe Haven
Considering alternative investments like real estate, commodities, or hedge funds can further diversify and potentially protect your portfolio.
These assets often have different performance drivers than traditional stocks and bonds, providing additional resilience in turbulent times.
Monitoring consumer strength is essential for understanding the broader economic landscape
The trends indicating weakening consumer strength, such as declining real wages, rising delinquencies, and decreasing savings rates, suggest potential economic challenges ahead.
Investors need to adopt strategies to mitigate risks associated with these developments. By focusing on sectors like healthcare, quality stocks, bonds, and alternative investments, investors can better navigate the uncertainties of a weakening consumer-driven economy.
Staying informed and adapting to changing economic conditions will be key to preserving and growing investment portfolios in these challenging times.
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