Yesterday: Investigating the Health of the U.S. Consumer - Consello (2024)

Echoing the Beatles song “Yesterday,” the U.S. consumer’s troubles “seemed so far away” just as of last fall.

Unfortunately, the narrative has begun to transition to a less optimistic shadow hanging over the consumer, as 79% of respondents¹ to the June Consumer Sentiment Survey by the University of Michigan expressed bearish sentiment about the economy for the year ahead.

To put things into perspective, the U.S. consumer emerged from the COVID-19 pandemic in a relatively healthy financial standing with a strong balance sheet and low leverage levels. Additionally, as the Federal Reserve and the U.S. government injected unprecedent levels of monetary and fiscal stimulus into the economy to combat COVID-19, the consumer found itself in a tight labor market with rising wages, higher levels of wealth, improved creditworthiness, and an increased ability to spend. As a result, the consumer still remains daring, as evidenced by elevated levels of spending with an increased reliance on revolving credit, recently rising 13.4% YoY to an all-time high of $1.1T. But with inflation rising to 9.1% in June and recently hitting a forty-year high though, rising prices are beginning to have an impact and are top of mind for many. In fact, 49% of consumers² now cite inflation as the top reason for the erosion of their living standards.

Consello’s Research Team has embarked on developing a proprietary scorecard, the U.S. Consumer Health Assessment Scorecard (see page 3), to unpack these developments and gauge the health of the U.S. consumer at present and its future implications for corporates. The scorecard is formed by assessing the current state of the following ten key factors: inflation, consumer confidence, business sentiment, personal savings rates and indebtedness, equity market performance, liquidity in the financial system, housing, spending trends, labor market trends, and consumer creditworthiness. This paper provides implications for a variety of corporates in the consumer facing sectors, including companies in the consumer discretionary and retail sector, paper and packaging, consumer staples, and financials/real estate. Indirectly, we also see potential implications for technology, industrials, and materials companies.

Based on our preliminary analysis, we would characterize the current U.S. consumer as one who is still balance sheet healthy, financially resilient and supported by a strong labor market. However, this same consumer is on what we believe to be a potentially unsustainable spending path, is pivoting in order to adapt to a rapidly changing economic environment, and is starting to more acutely sense the increasing uncertainty of the future.

The consumer is readjusting to this new economic environment, but the process is taking time, as shown by spending levels that remain high (retail sales up 8.4% YoY in June 2022 and well above pre-COVID levels), with a noticeable reallocation of resources away from savings and toward spending. While personal income has risen 13.7% versus pre-COVID³, the personal savings rate has fallen by 27.4%. Similarly, savings rates were as high as 30.5% in April 2020, when the IRS issued the first economic impact payment (EIP) of $1.2k per eligible person, but this rate has now fallen back to approximately 5% and remains below long-term historical levels. These factors have resulted in consumer behavior that is somewhat less than prudent, such as higher credit utilization. Admittedly, there is a psychological element to the observed elevated spending patterns stemming from the social isolation experienced during COVID-19 lockdowns and social distancing measures. As a result, the consumer is now spending more on dining out and travelling in an effort to compensate for missed experiences during the pandemic. The consumer is potentially making other bold decisions, as observed by the rising quit rate, which is materially elevated versus pre-COVID levels. While this signals strong optimism in terms of labor market opportunities and the ability to find a job, it also coincides with a challenging macro backdrop. Gas prices, up 30% YoY⁴, are a particularly meaningful headwind. To the positive, housing remains robust, and the home-owning consumer is feeling wealthier. These dynamics, together with a strong labor market, explain some of the discrepancy between general consumer sentiment, which has deteriorated, and actual consumer spending behavior. The dichotomy has created an environment where fear for the future resilience of the U.S. economy and an expectation of continued financial opportunities can coexist.

In conclusion, we believe that the U.S. consumer’s financial profile remains moderately healthy given the strength of their balance sheet versus other economic downturns observed, such as the Global Financial Crisis (GFC). With the labor and housing markets remaining strong and consumer leverage at historically low levels albeit increasing, the consumer remains resilient for now, but their buffer may be decreasing. Today’s consumer faces abnormal economic times, defined by unprecedented inflationary pressures and stock market volatility that are heavily impacting their balance sheet, just as federal stimulus programs have started to run off. In addition, US GDP shrank for the second consecutive quarter in July, meeting the technical criteria for a recession. Meanwhile, the CEO Confidence Index, which acts as a method of evaluating the health of the U.S. economy from the perspective of U.S. CEOs, has now fallen to a decade low. While there are some schools of thought suggesting that inflation may already be moderating, we still see risks to the consumer health. As prices are likely to stay elevated in combination with wage rate increases below the rate of inflation, these patterns may further lead to spending pattern shifts and some cutback on discretionary items.

Consello’s Predictions

As the consumer grapples with the aforementioned conflicting economic factors, they are becoming less confident given high inflation and economic uncertainty. Likewise, the consumer’s financial resilience is also incrementally softening as observed by falling savings rates, rising revolving debt, and lower stock portfolios. This is particularly relevant for people with lower income. Our analysis of the ten macroeconomic factors related to the health of the consumer provides insights that may be relevant to an audience of various companies and sectors, cited above.

• An increasingly less confident consumer may see their financial resilience weaken.
  The broad conclusion, based on our research, is that while the consumer remains moderately healthy today, they are gradually weakening and becoming less confident as we enter a future period of heightened economic uncertainty. With the Fed hiking rates, we expect the labor and housing markets to cool off, potentially decreasing the consumer’s financial buffer against a downturn. As a result, we predict that consumers’ financial resilience and creditworthiness may likely worsen.
• Consumer spending may slow, leading to a reduced corporate revenue outlook.
  While discretionary spending remains elevated today, it will likely adjust downward as inflation continues to take a larger share of households’ disposable income. A pullback in spending will have an impact on the corporate sector and on the overall economy that faces a near-term slowdown. We predict that revenues for select corporates may stagnate or even contract. This may be especially pronounced among consumer-facing businesses, while other sectors like industrials or technology may also feel the negative impact. Businesses are already seeing demand soften and CEO confidence has dropped, and we expect discretionary spending to pull back further as consumers’ purchasing power erodes due to high inflation, posing a threat to business growth in the near-term.
• Unemployment rates to increase.
  We believe that we are in the beginning phase of a potential economic slowdown and one that could lead to an inevitable need to reduce costs in order to manage earnings. Slowing economic demand could therefore lead to a reduction in the labor force and ultimately drive higher unemployment. And even for those employed, the further reduction of wage increases will only magnify the effects of inflation at its current levels.
• Potential for additional downward revisions in Street estimates.
  These dynamics may make the jobs of corporate C-suites and investor relations (IR) teams more challenging given the amount of uncertainty and the difficulty in forecasting and providing adequate guidance. While economic slowdown fears are abundant, we could see potentially more Analysts lowering their growth estimates for 2H22 and 2023. On the business front, inventory management, expense management and pricing decisions will become even more important to adjust to a new normal.

We acknowledge that commodity prices and freight rates, which have had some historical correlation with inflation, have eased, but they still remain at elevated levels relative to pre-COVID. Given this, it is possible that inflation may lessen earlier than expected. However, we remain committed to our conclusion given that many companies have already passed along input costs to consumers through pricing and are unlikely to lower them now that a new pricing level has been established. In addition, as the Federal Reserve’s rate hikes flow through the economy, each hike taking around 12 months to take full effect, liquidity will tighten, and larger purchases will become less affordable for consumers, reducing spending ability. This tightening of liquidity will likely be amplified by the Federal Reserve’s intent to reduce its balance sheet in the near term, with monthly reductions of holdings of Treasuries and agency mortgage-backed securities reaching up to $95B by September 2022. The yield curve appears to be capturing the implications of the Fed’s monetary policy, becoming increasingly flattening compared to the start of the Fed’s hiking cycle, which began in March 2022. Rising shorter-term yields signal that investors believe that the Fed’s forward guidance regarding its hiking cycle is credible, while longer-term yields hint at a potential economic slowdown.

Q Consello Scorecard

Below is a scorecard of our findings that measures current U.S. consumer health across ten broad macroeconomic factors. Each factor is graded on a scale of one to ten, one being highly bearish, ten being highly bullish, and five being neutral. To determine each factor’s individual score, we analyze each factor and compare it to historic peaks and troughs, allowing for a more holistic and qualitative approach.

Adding the individual scores for each factor, we arrive at a total score of 60 (out of 100). We view a score of 60 as a snapshot in time capturing that today’s U.S. consumer is still somewhat healthy, while risks to the downside exist. In particular, confidence levels are low, but spending continues regardless of significant inflation, while housing and the labor market remain strong. The consumer is still digesting inflationary pressures and remains a creditworthy borrower. However, we acknowledge that this score has declined versus the past two quarters, and we believe that there is further risk to the downside over the next six to twelve months.

For reference, a time period with a materially higher score was Q4 ’19, the last quarter of the longest economic expansion in U.S. history. Conversely, a time period in history with a materially lower score was Q1 ’09, when 30% of mortgage holders felt underwater on their mortgage⁵, unemployment was high, and the delinquency rate was elevated.