Consumer Behavior Amid Economic Uncertainty

Economists are closely watching consumer spending, the biggest driver of the American economy, as a key indicator of the nation's economic health. So far, the signs aren’t promising.

 

TCW’s Head of Fixed Income Portfolio Specialists David Vick sat down with Senior Credit Analyst Tania Salomon and Co-Head of Credit Markets Steven Purdy for their perspective on how recent data from major retailers show a shift in consumer behavior. Shoppers are increasingly focused on bargains and hesitant to make big-ticket purchases, raising concerns about the sustainability of economic growth. This shift comes at a time when inflation remains stubbornly high and interest rates weigh on household budgets.

 

Financial experts warn that this shift could have broader implications for the overall economic outlook. The Federal Reserve’s efforts to navigate a soft landing may be challenged if consumer spending continues to weaken, potentially leading to a more pronounced slowdown in economic activity. Sectors like retail, leisure, and luxury goods are already feeling the impact, with mixed earnings reports and lowered forecasts becoming more common.

 

Whether you're concerned about your portfolio or simply trying to make sense of the economic whirlwind, this discussion aims to offer clarity amidst the volatility. The following is an abridged version of observations from TCW's Investment Insights Focus on Fixed Income podcast. For the full discussion, please visit TCW Investment Perspectives podcast: Signals from the Checkout Lane.

 

What are your thoughts on the consumer right now, overall?

Tania Salomon: We think the consumer has entered a new stage over the past three to six months. Covid was characterized by binge-ordering ‘goods’ to the home. Post-Covid saw a boom in ‘experiences’ which drove demand for leisure activities and ‘revenge travel’. It’s clear the post-Covid leisure boom has ended, and 2024 feels like our first normalized consumer environment in quite some time. Over the last two quarters, a new theme of ‘cautiousness’ has emerged across the companies we cover. We don’t see a demand ‘cliff’ per se, but management teams have been consistently describing a consumer who is incrementally picky about their spending, shunning large discretionary spending, reducing check size, and being more responsive to price. A picture has emerged of households feeling the cumulative pinch of inflation and being forced to be more measured by prioritizing spend on essential goods rather than discretionary options.

 

Is that feeling of caution consistent across all levels, all retailers, or is it isolated to particular sectors?

Salomon: I'd say the sense of cautiousness or ‘choicefulness’ is widespread across all consumer sectors—food, daily consumables, discretionary goods, apparel, restaurants, leisure, and lodging. There is still demand for all of these categories, but all are seeing an underlying deterioration in tone. Daily consumables (toothpaste, detergent, toilet paper, etc.) are the least impacted. Food is seeing a shift to private label and away from higher-priced branded products. Restaurants are engaging in ‘check management’ (ordering a burger instead of steak or skipping appetizers), emphasizing ‘value meals’ and overall lower foot traffic. In lodging, group travel is a bright spot, but all other travel is weakening as nearly every company lowered their Revenue Per Available Room guidance for 2H ’24. And in retail, we’re seeing higher-income cohorts ‘trade down’ by shopping at stores with lower price points compared to their spending a year ago. So while there are certainly nuances, the overall theme across sectors is that of a slowing consumer after a remarkable run.

 

Steven Purdy: I would add that while certain companies are faring better than others, the overall tone from management teams has incrementally deteriorated over the course of the year. All companies are expressing less confidence about their ability to predict the forward path of consumer behavior. Even companies that have met guidance are expressing more uncertainty about the future.

 

Are you seeing a difference between high-end and low-end consumers? Does that matter for the economy?

Salomon: We have definitely seen a bifurcation between the lower end and the higher end for several quarters now. Generally speaking, the high end has been very resilient while the low end is very challenged. There are numerous examples to reinforce the narrative on both sides. In terms of impact, the top 25% earners in the US account for almost half of consumer spend, whereas the lowest 25% earners account for 10% of consumer spend. So that high-end consumer really is crucial to the overall health of the economy.

 

An old adage is “never bet against the US consumer.” Are companies being too cautious about the consumer?

Purdy: Let’s spend a moment on the ‘bull case’ for the high-end and low-end consumer. For the low end, the most positive narrative is ‘it isn’t getting worse’. While credit card companies are seeing rising delinquencies, there is a decline in the rate of change month-over-month, so some believe this is the first derivative of stabilization. The high-end cohort's resilience is really driven by the wealth effect from high home prices and an all-time high stock market. We aren’t calling for a major pull-back in either, but we believe these consumers can change their spending quickly if there is volatility or increased uncertainty. A number of CEOs have commented that their consumers are remarkably aware of the risks around macro uncertainty—elections, geopolitical conflicts, interest rates, inflation, markets, etc. Our view is if there is any meaningful volatility on this front we could see an abrupt pull-back on spending at the high end.

 

What about the job market? What are you hearing from companies? What could cause layoffs to occur?

Purdy: During Covid, managers were quick to let go of people. They immediately regretted that decision and we pivoted to a world of ‘labor hoarding’ for the ’21-’23 period. We are now seeing a much more balanced labor market at the company level. To be clear, management teams don’t feel like they are on the verge of large-scale cuts, but at the same time, we don’t think they would hesitate to pull that lever if they felt it was necessary. In terms of what could cause future layoffs, we’d highlight the retreat in price inflation. This is great news for consumers and the Fed, but it presents challenges for companies. Companies have been able to push price freely over the past few years without a big hit to demand. We’re seeing ‘elasticity’ rising across companies which is reducing the ability to raise prices, dampening the top line, and causing margin pressure. Typically, when companies can’t control price or growth, they focus on cost. This often leads to headcount reductions over time.

 

What do you think the Fed is going to do from here? Will it help alleviate stress on the consumer? How are we positioning now?

Purdy: Our base case has been the Fed will start to reduce rates from currently restrictive levels. While this is positive for consumers, we think the positive impact will be felt with a lag. So reducing rates will not immediately translate to a strengthened consumer. In terms of positioning, we continue to be defensively positioned in credit. This is informed by both our concerned view on the consumer and economy, but also by the fact that credit spreads (our preferred metric) are at historically tight levels. We expect spread widening in the future and prefer to use those moments as entry points to add credit exposure.