Link’s Favorite Long-Term Themes: The American Consumer

Spend, Spend, Spend

In 2023, the U.S. economy created north of $27 trillion in value. The U.S. consumer accounts for 70% of the economy, equaling nearly $19 trillion last year alone. This spending makes its way through all sectors of the economy, including housing, transportation, food, insurance, healthcare, entertainment, and more. Amidst growth and recession fears, the American consumer has remained resilient. In the second quarter, retail sales grew 2.5% y/y, which carried into July with sales up 2.7% y/y.

With inflation on its descent lower, wages have followed but remain above historical levels. Hourly earnings grew 3.6% y/y in July, up .20% m/m and beating expectations for a -.1% m/m decline. This is above the 10-year median of 3.32% y/y, and in line with the 10-year average of 3.6% y/y. American consumers have enjoyed the benefits of a strong labor market, solid growth coming out of the pandemic, and healthy household balance sheets. Last month, Deloitte’s financial well-being index hit a four-year high as higher-income consumers have seen their financial situation improve, with rising optimism regarding personal finances across cohorts.

Chart 1: Deloitte’s Financial Well-Being Index Hits a Four-Year High^[1]

Second Quarter Retail Earnings Show Bright Spots

Most of the retail companies reported earnings for the second quarter and there was a common theme – if the companies had the right product at the right price, there was strong demand. Of course, execution also played a significant role. Clear winners were Walmart (WMT), Target (TGT), Costco (COST), and Amazon (AMZN) as they continue to take share from the department stores and dollar stores.

WMT beat top and bottom-line estimates and increased full-year guidance to 3.75-4.75% sales growth relative to the previous 3-4%. U.S. same-store sales grew 4.2% y/y, with e-commerce growth of 22% y/y. A promising statistic was that WMT’s general merchandise segment (items ex-groceries) grew for the first time following eleven consecutive quarters of declining sales.

Its management team mentioned numerous times that they are seeing no signs of deteriorating conditions across consumer types. WMT is lowering prices and providing value to consumers across all income levels with over 7,200 rollbacks across categories. Both the CEO and CFO mentioned on the earnings call that the company is seeing no step down in consumer spending and that activity remains healthy. WMT is up ~47% YTD and is the best-performing consumer staple in the S&P 500 this year.

TGT also beat top and bottom-line estimates last quarter and increased its full-year earnings guidance. Same-store sales grew 2% y/y, the first quarter of growth since Q4 2022. The company saw traffic growth of 3% with an average ticket decline of -0.90%, both better than expected. Management noted that traffic growth was a key driver for TGT in the quarter. Over one billion trips were made to the store in the first half of 2024, up more than 20% since 2019. New innovations have also helped the company, with its “Drive Up” grocery delivery program and Target Circle both seeing double-digit percent growth.

TGT echoed similar comments as WMT regarding the state of the consumer. TGT CEO stated, “Consumers have shown remarkable resilience in the face of multiple challenges over the last several years, and they remain resilient today.” Consumers are being selective and looking for value, but that does not mean activity is slowing. TGT has broadly lowered pricing for many of its offerings, which has been successful with traffic improvement and average ticket costs declining. TGT is likely to see continued momentum with back-to-school in season and the holidays around the corner.

COST continues to be a juggernaut in the retail space. COST trades at a forward price-to-earnings ratio of nearly 50x, higher than many mega-cap technology companies. COST has 74.5 million paid members, which grew 7.8% in the last quarter. The $130/year executive membership now represents nearly half of all paid members and 73% of its worldwide sales. Traffic increased 5.5% in the previous quarter, and COST’s CFO said that value and quality have never been more important for consumers, which aligns directly with COST’s long-standing focus. COST, like WMT and TGT, sees a “very healthy consumer” especially in its non-food, discretionary items.

But brick-and-mortar retailers also compete with AMZN, which continues to expand into new industries and take share from competitors. AMZN has transitioned its business model away from its root of just a consumer-focused business, but still provides great insights into the state of the consumer. Management mentioned that they saw consumers trading down and looking for deals last quarter, but their customers are buying larger ticket items at a higher rate than their competitors. AMZN saw retail sales grow 9% y/y in North American and 10% y/y internationally.

Chart 2: Walmart and Costco are Outperforming the Market by +20% YTD^[2]

Not Just Retailers Experiencing Consumer Strength

A number of financial institutions have recently commented on the state of the consumer. American Express’ (AXP) CFO said the consumer continues to be “stable in a slow-growth economy”, and nothing has changed over the last 6-7 weeks. AXP’s card fee revenues were up 16% y/y in the previous quarter, and credit performance remains very strong. JP Morgan (JPM) said consumption is still there and consumers are in relatively good shape, and Mastercard (MA) mentioned that its view that consumer spending remains healthy continues. Major banks and lenders are not warning of any sign of deterioration, in line with what retailers have seen over the last few months.

Sectors of the economy outside of food and staple retailers are seeing similar consumer resilience. LVMH (LMVHF) has a portfolio of companies ranging from clothing to accessories and alcohol, such as Louis Vuitton, Zenith, and Tiffany & Co. Through the first half of the year the company was hit by a weakening segment in China but saw 2% revenue growth in the U.S. and 57% growth in Japan. Sephora hit record high levels of revenue and profit earlier this year with significant market share gains in the beauty industry. LVMH is trading at historically cheap valuation levels in a healthy economic environment.

Simon Property Group (SPG) is another consumer-exposed company trading at historically cheap valuations. SPG owns and manages premier shopping, dining, and entertainment real estate mostly in the United States. Coming out of Covid-19, commercial real estate was considered a pastime, but SPG continues to see strong demand across its locations. At the end of the second quarter, occupancy rates for SPG were 95.6%, up 90 bps y/y, and the company signed over 1,400 leases for 4.8 million square feet in the quarter. Traffic was up 5% y/y and total sales volumes increased 2% y/y – no signs of a consumer pulling back. SPG’s CEO mentioned that lower-income consumers have been under pressure due to inflation, but the lower-end consumer is cycling out of this as the forward-looking inflation picture appears to be benign. Also, there has been no wealth impact on the higher-end consumer whatsoever.

Continued Resilience Going Forward

American consumers have largely been able to withstand higher interest rates. Mass-induced stimulus following the pandemic improved household balance sheets and record low mortgage rates assisted in home affordability. Today, the effective outstanding mortgage rate is 3.9%, and almost 40% of U.S. homes do not have a mortgage. Inflation has fallen to the Fed’s 2% goal with interest rate cuts to come later this year and into next year.

Altogether, the consumer is in a solid position. Wages are growing in the 3-4% range, with inflation at 2% and 1.2 job openings per 1 unemployed person. What we heard from major retailers is that the consumer is spending and remains well balanced. If retailers have the right product and pricing, there is demand. As 70% of the U.S. GDP, we expect continued momentum and growth from the U.S. consumer.

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Sources

^[1] Source: Deloitte. As of August 30, 2024.

^[2] Source: FactSet. As of September 9, 2024.

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