The economic landscape in the United States has been fraught with challenges, as consumers grapple with escalating prices and seek ways to manage their spending. Recent indicators suggest that these consumers are nearing their financial limits, raising alarms on Wall Street about the sustainability of current spending patterns.
As inflation data emerged this week, the market's trepidation grew. January's inflation rate was reported at 3%, marking an increase for the first time in seven months. This news sent shockwaves through the stock market, triggering a significant downturn. The reliance on consumer confidence is paramount; a decrease in spending can exacerbate investor anxieties, particularly within sectors like retail and consumer essentials.
The market has seen a surge this year, with the S&P 500 index posting a close to 2% rise thus far. However, this upward trend has not been mirrored in retail-focused investment vehicles, with the SPDR S&P Retail ETF falling in response to growing concerns about consumer behavior.
For the last few years, American consumers benefitted from an increase in stock market values, elevated savings, and a robust job market that sheltered them from rising prices. Despite the Federal Reserve’s goal of maintaining inflation around 2%, retail sales have shown resilience, especially as the 2024 holiday shopping season approaches. However, analysts are warning that the retail outlook for 2025 looks increasingly uncertain, as changes in Washington’s policies may play a significant role in shaping economic dynamics.
The debate surrounding tax rates adds another layer of unpredictability. The government’s current fiscal plan is only expected to last until March 14, and thereafter, the issue of the debt ceiling could come back into the spotlight. Chris Krueger from TD Cowen's Washington research team remarked that this situation is poised to dominate headlines soon.
Beyond inflation, specific risks within the retail sector warrant attention. Investment bank Jefferies recently issued a warning that U.S. retail inventory levels have risen for the first time in two years, potentially outpacing sales. This scenario previously led to notable impacts on retail profitability and operational forecasts when it last occurred.
Jefferies analyst Randal Konik emphasized that a stronger dollar poses challenges for non-essential consumer goods companies that operate internationally. Compounding these concerns, the year 2024 introduces an additional sales week, complicating year-on-year comparisons for 2025.
Another trend to monitor is foot traffic to shopping malls, which Jefferies indicates may be on the decline as of December 2024. While traffic remained above average post-pandemic, there are signs that it is normalizing. Dwindling foot traffic typically suggests that consumers are becoming more price-conscious and gravitating towards items with better value propositions.
Konik pointed out that despite the overall health of consumers, their purchasing decisions are becoming more selective. Recent survey results from Synchrony Financial indicate that shoppers are prioritizing essential goods while cutting back on discretionary purchases. Additionally, years of price increases have begun to erode companies' pricing power, making it more challenging to maintain margins.
Max Rakhlenko from TD Cowen expresses caution concerning the short-term trajectory of high-priced goods like luxurious furniture and automotive parts. From a technical perspective, Jonathan Krinsky of BTIG has observed a concerning trend: non-essential consumer stock performance is weak, while essential consumer goods stocks are thriving.
Krinsky elaborates that the ratio between non-essential and essential consumer goods stock prices is often a crucial metric for gauging consumer well-being. A prevailing trend toward essential goods, particularly when calculated equally, could signal potential downturns in consumer sentiment.
Upcoming retail sales data is anticipated to provide further clarity on consumer behavior. However, Aditya Bhave, an economist at Bank of America, cautions that this data may not be particularly robust. According to credit card transaction data, household spending decreased by 0.4% month-over-month in January (seasonally adjusted). Additionally, some consumers might be hoarding certain items in anticipation of rising tariffs, which could lead to diminished sales in specific categories down the line.
Despite the challenges at hand, there is no immediate cause for alarm among investors. While demand for luxury items may be waning, sales across other categories remain stable. John Kernan from TD Cowen highlights that retail sales figures are still above the historical average from the past 25 years, reflecting continued consumer expenditure resilience. Moreover, improvements in credit default rates and the robustness of the job market provide additional support.
"The overall state of consumers remains strong," Kernan stated, advocating for a positive outlook on consumer confidence. "We should maintain an optimistic perspective regarding their spending capabilities."
Bank of America also posits that the observed drop in consumer activity for January is likely a transient dip rather than a pivotal shift in trends. The institution suggests that adverse weather events like wildfires and snowstorms may have contributed to the decrease in consumption. Considering the solid health of household balance sheets and the steadiness of the job market, current data may better reflect a reallocation of consumption rather than an actual downturn in spending capacity.