One of the wisdoms commonly held by stock pickers since the early 1980s had been never to bet against the U.S. consumer.
The structural decline in interest rates and steady build-up of consumer debt had been fueling demand for consumer goods and services for several decades. This investment premise was put to the test during the global financial crisis as the housing bubble burst and the tightening of financial conditions put pressure on discretionary spending, marking the end of the consumer boom.
But new clouds started gathering above the retail sector in the form of disruptive competition from Amazon and other online players. Some on Wall Street even made money betting against the U.S. consumer.
But new clouds started gathering above the retail sector in the form of disruptive competition from Amazon and other online players.
However, such a strategy would have not been a particularly profitable strategy of late, as the most recent releases from consumer stocks have demonstrated that they are on an increasingly solid footing. Americans are spending.
As goes Walmart, so goes America
The once undisputed bellwether for mainstream consumer demand has just reported its best sales growth in over a decade – a truly blowout quarter, sending Walmart shares up 10% on the day. The upsurge in consumer demand has been mirrored by upbeat reports from several other mainstream retailers.
The most notable positive surprises came from Target, second only in size to Walmart, and from DIY icon Home Depot. Even department stores such as Nordstrom and Macy’s, once thought to have lost their luster (and customers) to Amazon, posted rosy outlooks.
The second quarter reporting season has now come to an end and the results are quite telling. At aggregate level, the releases from consumer names were strong – 85% of S&P 500 consumer discretionary and 90% of consumer staples companies exceeded analysts’ expectations.
Consumer discretionary stocks recorded the biggest positive surprise, exceeding expectations by an average 8.3%, the highest across all sectors. This strength is likely to continue over the next quarter given that retail sales jumped again, to 6.4% year-on-year during July.
CHART 1: U.S. retail sales growth
What lies behind this strength? The U.S. unemployment rate has just dipped below 4%, and job creation remains solid. Home prices are high again. It is therefore little surprise that consumers are feeling good about the strength of the economy and the health of their own finances. Tax cuts have added extra dollars to consumers’ pockets even if paycheques have not been growing particularly strongly.
CHART 2 – U.S. consumer confidence index
The latest reading of consumer confidence indices reflects this optimism, driving headline figures to their highest levels since October 2000. This confidence about future prospects and current conditions may explain the pickup in spending, accounting for both the increased traffic and enlarged basket size. If sustained, the strength of America’s spending has a potential to add fuel to the stock market and the U.S. economy.
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Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.