Consumer Tailwinds Could Blow Us Out of the Summer Doldrums

Thoughts

• The markets have entered a period of consolidation following a strong run for five-straight months, with the S&P 500® Index down fractionally for the week and down 3% to date in August. Stalled momentum is not unusual in August and September, with a dearth of catalyst and vacation schedules resulting in the only two-month span of negative historic market returns on the calendar. The market will be searching for a catalyst in the coming weeks, with the corporate earnings season ending, the FOMC meeting more than a month away, and many important macro data points behind us. Interest rates are a growing concern, with the 10-year and 2-year yields flirting with the highest level since 2007 and financial conditions tightening. Many risk metrics remain benign, including credit spreads, the VIX, and the put/call ratio, suggesting this period of weakness in the market is likely temporary.
• The 20% rally through July greatly shifted the scenario investors were pricing into shares from extreme pessimism to modest optimism. Given this shift, the burden of proof is more balanced between bulls and bears. Bulls continue to point to gradually softening inflation, the perceived end of the Fed’s rate cycle, general health of the consumer, and encouraging earnings season. Bears are increasingly focused on the perceived deterioration in credit following the US debt downgrade by Fitch and Moody’s cut to the ratings of ten banks and warnings on several others. Other concerns include rising uncertainty in China, labor costs given the UPS deal with the teamsters, and looming tensions with the auto workers and in Hollywood. Technical factors have been a tremendous tailwind for markets over the past ten months as sentiment and positioning shifted from historically pessimistic to neutral, or in some cases, optimistic.

• In light of the recent period of market consolidation, the fourth-quarter outlook remains cautiously optimistic, benefiting from anticipated tailwinds. Consumer spending has fueled this year’s market strength, but rising credit card delinquencies and the need for additional data to gauge consumer health have put recent market tailwinds in perspective. Sectors like tech and communications services have led the rally, though cracks are appearing in areas dependent on consumer spending. The market appears balanced for now, but as we head into the fall, it is crucial that we watch consumer health, the job market, and the interest rate environment for potential shifts.

News

• The consumer’s strength will be displayed this week with retail earnings and a report on retail sales. Last week, the University of Michigan’s latest survey revealed a slight decrease in consumer confidence among Americans compared to July, yet it surpassed expectations. While positive consumer data continues to signal a resilient consumer, indicators might suggest a potential deceleration in consumer activity. Credit card delinquency rates are hitting levels not seen in over a decade as consumers increasingly turn to credit cards to offset affordability issues. According to the New York Federal Reserve, credit card debt increased by over 4% from April through June, reaching $1.03 trillion, the highest value since 2003. The credit card debt delinquency rate also rose to 7.2% in Q2, the highest rate since Q1 2012 but still close to the long-term average, while overall debt delinquency increased slightly to 3.18%. Lastly, as mortgage rates top 7%, affordability issues continue to plague homeowners and renters.
• Inflation data came in largely as expected this week, with consumer price inflation running at 3.2%, marginally lower than the 3.3% estimate, but the first sequential acceleration since last June compared with the 3.0% the previous month. Core CPI was 4.7%, slightly better than the 4.8% estimate and 4.8% in June, as food prices continue to moderate. Used car prices and airfares dropped significantly, while shelter costs remain sticky at nearly 8% growth versus a year ago. Rental and home price data suggest this will ease in the coming months, though the lagged effect of the calculation remains an issue. Producer price inflation remains well below the pace of CPI, with headline PPI up 2.4% and core up 2.7%. Inflation should continue to moderate as shelter costs ease, though the comparisons from a year ago will become more challenging, and energy prices are a growing headwind with oil prices near the highest level since last November.
• Earnings season is largely behind us, with over 90% of the S&P 500 companies having reported. Earnings are heading for a decline of less than 5% versus a year ago, notably better than the 7% decline expected at the beginning of July. This represents the third-consecutive negative quarter and the weakest results since the beginning of the pandemic. Good news is on the horizon, however, with the third quarter expected to grow, with continued healthy demand, easing margin pressures, and less of a headwind from the dollar. The third quarter is expected to see growth of less than 1% (unchanged since May), with the fourth quarter forecasted to grow by 8%. The current consensus is for 1% growth in 2023 (unchanged since March), with an acceleration to 11% growth in 2024. Next week will be highlighted by retail and technology earnings, with reports from Target, Walmart, and Cisco, providing a view into the health of consumer and corporate spending.

What to Watch

• Retail and technology earnings will be in focus next week, as economic data is limited. Releases include retail sales on Tuesday, housing starts, and industrial production on Wednesday, and leading indicators on Thursday. The minutes from the recent FOMC meeting will be released on Wednesday.