ACTV - Pulse Check: The Consumer

2023-06-16 10:30:00 ET

Summary

• For the last year, conversations centered around the Fed and its aggressive interest rate hike campaign to bring down decade-high inflation. What’s at risk? A recession, which is, in fact, our current outlook.
• The pandemic and relate economic relief-fuelled excess savings became a catalyst for consumer spending that allowed them to continue buying despite rising inflation.
• While we are starting to see cracks in the forward-looking economic data, areas of the consumer still look healthy.

For the last year, conversations centered around the Federal Reserve (Fed) and its aggressive interest rate hike campaign to bring down decade-high inflation. What’s at risk? A recession, which is, in fact, our current outlook. As a result, there has been a degree of market volatility as investors parsed through and compared economic data, earnings reports, and the Fed’s policy. Beyond all this news, how is the consumer faring?

To gain a complete picture of the consumer, the story begins well before the Fed’s inflation battle began. In 2020 during the pandemic, Congress passed the CARES Act to provide economic relief directly to households. This included checks along with pauses on loan payments and lower borrowing costs, which all flooded the economy wish cash.

In the fall of 2021, the Fed reported that excess savings totaled $2.3 trillion. The excess savings became a catalyst for consumer spending as lockdowns ended and consumers had pent-up demand (and cash) that allowed them to continue buying despite rising inflation.

With consumers having the stockpile of cash and the appetite to spend, companies responsible for producing the goods and services have been met with their own challenges. To keep up with demand, indicators show that companies raised wages to retain employees in order to have enough support to continue generating supply. To offset raising wages, companies also raised prices - another factor contributing to the high inflation that consumers are seeing. This is where we began seeing the disconnect with inflation, consumer sentiment, and economic data.

Fast-forward to today

Now, mid-way through 2023, those three players are still very much in the game. While we are starting to see cracks in the forward-looking economic data, areas of the consumer still look healthy. As the pandemic has played out, the composition of the workforce evolved. Existing job titles, staffing, and roles were adjusted and expanded to remain resilient. Despite these changes, today the labor market has shown few signs of weakening, providing the Fed ample cover to continue down its current path of rate hikes, even if this plan does involve pausing for a month to see how data reacts.

Additionally, jobless claims have increased well above the estimated 235,000 to their highest point in 20 months. The increase in claims is parallel to the lagged effect of the Fed’s tightening of monetary policy. Coinciding, unemployment rates have continued to rise, creating less cash for consumer spending and tolerance to the inflationary prices.

The latest consumer spending report highlighted a 0.8% uptick in April from the month prior, which supports the resilient consumer and that they’re still willing to spend. However, an emerging trend to keep an eye on is the pain of the lower-end consumer. Compared to the middle and/or upper class, the lower-end consumers are hurting the most from our current economic state.

Are there investing opportunities?

When there’s lemons, make lemonade, right? With a recession as our base case, our portfolios are favoring a defensive positioning. Therefore, our analysts are working to identify companies with strong characteristics that can generate strong cash flows through this economic cycle and have competitive positions within their industries.

To put that methodology into practice, here’s insight into how our analysts are thinking about the global alcoholic beverage market, which is constantly growing. The industry has been resilient irrespective of the economic environment. Revenue for these companies continuously remains positive, even amid our current outlook of a recession. Specifically, spirits are gaining popularity on a global basis, which reflects changing consumer preferences and the emergence of new categories, such as RTDs (Ready-To-Drink cocktails). There are also bright spots of development that still exist within beer companies. More broadly, across the space, we are seeing continued growth in premiumization, whereby the fastest growth is occurring within the higher-priced products. That’s a tailwind for producers.

As active managers, our Research team is focused on analyzing companies like these against our investing processes, profiles, and portfolios.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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