Consumer Resilience Displayed Across Discretionary Categories

Persistent Inflation Not Yet Deterring a Persistent Consumer 

The August headline Consumer Price Index (CPI) reported +0.1% m/m; this figure was higher than anticipated and the annual figure fell to +8.3% y/y, less than July but higher than expectations, driven again by lower gasoline prices. Service categories like medical care, shelter, education, restaurants and personal care continue to be the sticky components of inflation – fueled by wages and demand. Commodity prices are clearly more volatile, and lower energy commodity prices have driven this category down in recent months – though energy services, like utilities, are rising. 

Chart 1: Select CPI Categories, Reflecting Persistent Inflation Through August¹ 

While gasoline prices are still 63% higher y/y, those prices are now down -23% over the last 3 months and -4% in the past month, giving consumers some breathing room when it comes to discretionary spending. The price of brent crude oil has retreated roughly 11% from its August high of $104.81 in the global spot market. 

The strong labor market and normalizing demand gives us conviction that despite slower growth, we don’t believe the U.S. is currently in a recession. The jobs market remains hot with historically low unemployment claims and +4% y/y job openings. According to Bank of America (BAC), card spending per household increased +5% y/y, continuing to underscore that consumers have the capacity to spend. 

Chart 2: Bank of America Monthly Card Spending per Household² 

BAC also highlighted total payments increased 13% y/y in August, which was an impressive comparison to the +7% y/y increase shown in July. Payments were supported by still-elevated savings and checking balances relative to pre-pandemic, and higher wages. 

Chart 3: Bank of America Household Savings and Checking Balances³ 

Chart 4: Bank of America After-Tax Wages and Salaries Growth⁴ 

The U.S. is a nation of spenders. This spending data and consumer resilience, despite the high inflation, is apparent in earnings. And it’s also clear that companies broadly are passing through their own inflationary costs to grow revenues and profits at a healthy pace. 

Choose Your Adjective for Today’s Growth (Shifting, Slowing, Normalizing), but Not Recessionary 

70% of U.S. GDP is created by household consumption. Personal income was up +4.6% y/y in July, personal savings as a percentage of disposable income was up +5% in July, and retail sales were up +10.3% y/y in July. Despite the Fed’s aggressive policy, it’s yet to reflect that sizeable impact on aggregate consumption. Even as consumer behavior shifts/slows/normalizes, the consumer is resilient and paying for higher-priced goods and services. 

Consumer behavior has kept companies on their toes, whether it’s been a shift related to housing and rising mortgage rates, experiences vs. stay-at-home, or “trade down” vs. “trade up” themes. Companies are highlighting all of these themes, and certain names are performing strongly off the low expectations. 

Retail stores such as Walmart (WMT) highlighted consumers shifting down their spending habits toward essentials and bargain purchases. On the flip side, both Lowe’s (LOW) and Home Depot (HD) have highlighted consumers “trading up” to invest more in home improvement projects like new appliances and lawncare equipment, as new home sales trend lower. Home furnishing companies, RH (RH) and Williams Sonoma (WSM), both managed to beat low earnings and revenue expectations in Q2. Consumers with healthy balance sheets continue to upgrade their life at home.  

Further, beauty and lifestyle continue to trend positively among consumers. This momentum is particular noteworthy in companies like Lululemon Athletics (LULU) and Ulta Beauty (ULTA). Neither of these companies have pursued markdown strategies to attract consumers either; it has been authentic demand that has fueled strong earnings. LULU demonstrated this by posting, for the first time, guest traffic +20% y/y in Q2, with total traffic +30% y/y and e-commerce traffic +40% y/y. ULTA has been able to demonstrate its strong position in the beauty category with a variety of price points and brands that appeal to a broad consumer-base. ULTA reported same store sales of +14.4% y/y, transactions +8.3% y/y and average ticket growth +5.3% y/y. Underscoring their confidence in the consumer, ULTA raised guidance for the rest of the year. 

Using Earnings Trends and Sentiment to Build a Thesis 

With more than 99% of S&P 500 companies having reported Q2 earnings results, there are some insightful trends to highlight. S&P 500 Q2 earnings growth was +6.3% y/y – well above the +3.9% y/y expectation on June 30 – and revenue growth was +13.9% y/y – better than the +10.1% y/y expectation on June 30. Positive surprises were widespread, with 75% of companies beating Q2 EPS expectations and 70% beating Q2 revenue expectations.  

The consumer discretionary sector reported the second largest Q2 earnings decline of all 11 sectors at -18.1% y/y. The catch, however, is excluding Amazon (AMZN), the consumer discretionary sector reported +11.3% y/y EPS growth. At the industry level, much of the annual growth within discretionary is impacted by the y/y comps. For example, EPS for auto parts companies decreased -27% y/y, while automobile companies increased EPS +41% y/y. Similarly, internet retail EPS was down -117%, while hotel, restaurants and leisure EPS was up +1,958%. 

Despite the pockets of strength that we have mentioned, analysts are, again, pricing in a slower Q3, projecting EPS +3.8% y/y and revenue +8.8% y/y. These lower expectations indicate expectations that the consumer will begin to roll over, amid low sentiment and further policy tightening. It does not appear to reflect the higher income, higher account balances, and strong jobs market supporting a resilient U.S. consumer.  

The forward 12-month P/E ratio for the S&P 500 is currently around 16.7x, which is below both the 5-year average of 18.6x and the 10-year average of 17x. There’s a lot of negative sentiment baked in, given the macro policies, but we think consumers can overcome those low expectations in the second half and companies with strong management teams and differentiated/quality products will capture the variety of spending habits being revealed. 

Sources

1. FactSet (chart)
2. Bank of America Institute
3. Bank of America Institute
4. Bank of America Institute

Disclosures

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