Consumer Shift to Re-Opening Services

Inelastic, Pent-Up Demand

We’ve written quite extensively about the inflationary pressures that have been building over the past year. It’s important to watch these higher cost pressures and the impact to consumers. Last week, we got the hotter than expected CPI report at 7.5% y/y. This week the PPI posted a high number as well at 9.7% y/y. Within the report, the services inflation rose 7.8% y/y. These are all at levels not seen in 40 years and one of the main reasons the Fed will begin to normalize policy in March with the first rate hike since 2018. Importantly, the growth side of the economy is stronger than expected; Omicron has not led to a slowing of activity and instead we see better than expected reports in retail sales, industrial production, auto sales and ISM new orders. So while inflation is high, growth is above trend – something we’ve expected for some time. The key will be: does the Fed normalize policy with four interest rates or become more restrictive with more increases and beginning with the run off of the balance sheet.

While tightening monetary policy can be expected to slow the pace of economic growth, the pent-up reopening and services demand is real and will be a bright spot as it is 70% of the U.S. economy. 

Consumer Spending and Savings Rates Encouraging for Demand Continuation

The long runway for demand centers on the pandemic ending and economy reopening, and we could see a shift in demand towards services. The effects of a broad increase in capex can also start to improve capacity and productivity in the second half of the year, reducing inflation. More efficient supply chains, increased capacity, strong labor markets and continued demand from lifting restrictions offer the best opportunity for the Fed to execute a soft landing after raising rates.

Wages are rising and savings are elevated. This provides a strong backdrop for consumer spending growth, if the Fed can effectively manage inflation. Personal spending is growth is nearly 200% above the five-year average, highlighting the significant demand. While personal savings rates have lowered since their pandemic peaks, savings have normalized since fall 2021 and remain above pre-pandemic levels ($1.44 trillion), supported by higher income. The consumer remains strong and we’re paying close attention for any signs of demand destruction – none of which were discussed during earnings, besides the stay-at-home names.

Chart 1: Elevated Personal Spending (Outlays) and Income¹

Consumer goods retailers that maintain limited pricing power are experiencing margin pressures. Three trends we’re anticipating within the goods economy is the pent-up demand for new autos (timing uncertain), sustained demand for home-improvement / DIY trends (should housing market remain strong) and rising demand for industrial goods because of companies investing in their supply chain and inventory capacity.

While pent up demand is significant, uncertainties for reopening the services economy mainly relate to timing, and rely on lifting pandemic-related restrictions globally. There is no crystal ball to determine when international travel will return to pre-pandemic levels or what the future of business travel will look like. We are data dependent, and analyzing company expectations closely.

We have learned a significant amount from these reopening names during Q4 earnings calls. Expedia (EXPE) is optimistic about a strong travel recovery this year. Marriott (MAR) is leaning on international leisure demand to contribute to 2022 growth, sharing that “cross-border room nights in 2021 were down more than 60% compared to 2019, while domestic room nights were down 16%.” American Express (AXP) noted strong consumer travel spending, with overall T&E reaching 82% of pre-pandemic levels and U.S. T&E growing 8% above pre-pandemic levels. Disney (DIS) reported “all-time revenue and operating income records” at their domestic parks and resorts in Q4. This data contributes to the pent-up demand thesis flowing into international opportunities once restrictions are fully lifted. Both Caterpillar (CAT) and Stanley Black & Decker (SWK) shared their views on the strong customer demand across global markets – supportive for our bullish DIY / home improvement theme and industrial capex beneficiaries.

Year-to-Date: Value Outperforming, Opportunities in Quality Growth

While the S&P 500 has retreated year-to-date and outperformance has been driven by value vs. growth, the sell off could be generating an opportunity to buy growth companies at a good price. We’ve talked about the “earners” and “non-earners” within the growth category and our focus would be on buying quality earners with secular growth tailwinds at attractive valuations. Themes in this category may include automation, artificial intelligence, cybersecurity and cloud infrastructure.

Chart 2: Year-to-Date Return²

Chart 3: S&P 500 Price-to-Earnings Spread (High Minus Low P/E Stocks)³

Maintaining Cash to Counter Uncertainty

We remain flexible in our strategy during uncertain times by maintaining liquidity to seek more attractive opportunities. Our portfolio maintains the ability to shift, tactically towards cyclical or defensive, depending on what we see in the data. The uncertain outcomes from the ongoing shift in Fed policy makes the environment difficult for passive investing and we stay ready in our active management convictions.

Stephanie Link: CNBC TV Schedule

Sources

1. Credit Suisse (chart)
2. Credit Suisse (chart)
3. FactSet (chart)

Disclosures

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.