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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
The U.S. consumer is entering a new budget era.
With inflation lingering and spending habits shifting,
the economy's biggest driver is showing signs of fatigue.
Recent quarterly reports from major retailers reveal cautious shoppers who are
no longer snapping up big-ticket items but instead are hunting for bargains.
What does this mean for the broader economic outlook?
Welcome to Focus on Fixed Income, the TCW Investment Perspectives
podcast where we give you an inside look at what's driving
decisions in the world of bonds and credit markets.
I'm David Vick, joined today by Steve Purdy, Co-Head of
Credit Markets, and Senior Credit Analyst Tania Solomon.
In today's episode, we're digging into the cautious behavior
of consumers and what these changes signal for the economy.
As management teams share consistent concerns, these anecdotes
start to paint a clear picture, one that could challenge
the Federal Reserve's hope for a soft landing.
So, with that in mind, let's kind of start with the big picture.
What are your thoughts on the consumer right now, overall?
Sure. So, to understand where we are today, why don't we take a
step back and talk about what has happened over the last few years.
Going back to 2020, consumer spending during COVID was all about
goods, given the stay-at-home mandates and stimulus money.
There was a lot of pull-forward demand for goods in
2020 to the, call it, first half of 2021 period.
When the economy reopened, people still had
excess savings and shifted towards services.
And that's what the market called "revenge travel" or the
"leisure boom." That took place from, call it, 2021 to 2023.
From late '23 to today, there has been a slowdown, or what managements are
calling "normalization of leisure spend." The leisure boom has now ended.
And 2024 looks much more like an average year across both goods and services.
As to where we are today, if I had to summarize the consumer
in one word, I would characterize the consumer as cautious.
While we're not seeing detrimental demand cliffs yet, consumers
feel incrementally picky about their spending and continue to focus
on value as they work hard to manage their household budgets.
So, consumers are prioritizing their wallet dollars
on essential goods versus discretionary options.
You know, it's funny, all these CEOs start to use this word
"choiceful," which I'm not even sure is in the Webster Dictionary,
but it does seem to be across a number of different sectors.
And as Tania said, it's not a demand cliff, but it's an
incremental shift in the mindset of consumers that we're
starting to feel across a broad swath of the retail space.
And is that caution, is that feeling of caution, is that consistent
across all levels, all pillars, or is it isolated in particular sectors?
I'd say the sense of cautiousness is widespread.
Every management team is highlighting uncertainty in their outlook, but
there is this pressure on how certain businesses are being impacted.
We've definitely seen a mixed bag of results this earnings season.
In terms of essential needs within consumer products, for
example, so toothpaste, laundry detergents, toilet paper,
those are doing very well as consumers prioritize essentials.
In food, for example, we're seeing a shift towards private label.
In terms of more discretionary goods, so microwaves, washing machines,
barbecue grills, those categories are still facing a challenged
demand while showing some signs of early inflection.
Then luxury goods, we're seeing softer demand in general
and lower traffic from the aspirational consumer.
Then in retail, the consumer is still spending, but as Pertti
said, they're being choiceful as they're looking for good deals.
Then moving to leisure within restaurants, we
have seen several months of lower traffic.
This trend has been accentuated in fine dining, for example,
or in casual dining, your ticket sizes are shrinking
as people order the burger and not the porterhouse.
And then on the bright side, fast food companies are benefiting
from the higher income cohorts trading down into this category.
And then lastly, for lodging, group travel demand is doing really well.
So everything coming from your conventions, conferences, those are
outperforming, but the lodging sector as a whole is slowing down.
In fact, pretty much all lodging companies
lowered their ref bar guidance for the year.
So each industry has nuances, but the thematic view and direction
of the tone is one that clearly points out to a consumer,
which is slowing after a torrential run post COVID.
Yeah. And what I'd say to that as well is if you listen to all these companies,
regardless where they sit in the spectrum of, you know, relatively resilient
to really feeling the impact and you dial those back three or four
quarters, the tone across all of them has incrementally deteriorated.
So even the strongest companies at the high end are more
concerned now than they were the last two quarters.
And that's something that jumps off the page as
you listen to all the management teams discuss.
Right. Well, let's dig into that a little bit further because you both mentioned
sort of higher end consumers, and we've heard a lot about, well, the pinch is
really in the lower income cohorts and the upper income isn't really
impacted, but you look at other things like there's an index follows like the
cost of luxury watches is down 40%, you know, last six to 12 months.
What are you seeing in the higher end consumers?
Are they behaving differently, the lower end consumers?
And, and maybe importantly, does it matter?
We have definitely seen a bifurcation between the lower
end and the higher end throughout several quarters now.
Generally, the lower end remains challenged
and the higher end remains relatively healthy.
As a few examples, I guess, first on the lower end side, we see pawn shops, for
example, performing really well as the lower end seeks additional sources of
liquidity or off-price channels like TJ Maxx and Ross are
doing a lot better than your regular department stores.
McDonald's, for example, with the $5 menu,
seeing a lot of engagement from the lower end.
And then in lodging, we've seen a lot of incremental
weakness in the economy and lower chain scales.
So the lower end clearly continues to be damaged.
However, moving on to the higher end, again, while generally
healthy, we are seeing some small signs of slowdown.
For example, Walmart is gaining share from the high end consumers
as they seek value offerings or the least to own services are
seeing more applicants with higher credit scores versus before.
For perspective though, it's important to
note that the top 25% earners in the U.S.
account for almost half of consumer spend, whereas the
lower 25% earners account for 10% of consumer spend.
So that high-end consumer really is crucial to the overall
health of the economy and the lowest quartile, much less so.
Great. So an old adage that's been around forever
has been never bet against the U.S. consumer.
And here we're clearly talking about stress that we're seeing in consumers.
So what's the other side of the argument?
What are the opposing views that we should think about as we're
looking at the consumer, even in the face of some potential weakness?
Yeah. I mean, I think what Tania said is so crucial.
That highest cohort really drives the economy much more so than lower income.
And so let's talk about what other players in the market
on the corporate side think about the same question.
And one of the groups that has the best data and
the best insight is the credit card companies.
And they reflect a similar outlook.
One, the high-end, call it the Bank of America, JP
Morgan's, Visa's, American Express, spending is up and
the delinquencies are below normal, pre-COVID normal.
They're ticking up, but they're below normal.
The lower-end credit cards, and that's really kind of the Capital One and
Discover cards, they are seeing a pretty meaningful increase in delinquencies.
However, they have seen in the last two quarters, but particularly this
last quarter, the rate of rise in that delinquencies, and again, up is
bad for your credit card company for delinquencies, is diminishing.
So the first derivative of that change is slowing, and that gives them
some optimism that even the low-end might be feeling some stability.
So let's flip back to the high-end.
What is the big driver of the high-end continuous spend?
And in our mind, it's pretty clear.
It's the unemployment factor and the wealth effect.
Unemployment, obviously, we've seen that
jobs are not being lost in this country.
They might not be added as much as they have in the past,
but most white-collar workers feel pretty confident in
their ability to retain or get a new job if they need to.
The second thing is we're having this conversation about weakening consumer
in the face of all-time high stock market and all-time high house price.
And when you think about the house prices, not only are they
all-time highs, but the baby boomer generation, I think it's
something like 40% of homeowners don't have a mortgage.
And then 80% of those who do have a mortgage, it's fixed at a very low rate.
So they've really been unimpacted by these restrictive rates
the Fed has put on the cohort of people that rent a home
or have to finance a number of their goods and purchases.
So that is the reason we have such strength.
We don't see an immediate change to those factors, but what we would say is that
if you did get some sort of wobble in the stock market or if there is a slowdown
in the economy, we think that cohort can pull back pretty quickly
because a lot of the spending they're doing is discretionary.
And you mentioned the Rolex watches collapsing in price or
boats or RVs, those types of purchases have already come down.
You could see people, instead of going to the restaurant
and ordering the burger at the porterhouse, just stay home.
And that's what we kind of concern ourselves with when we think
about the slowdown of that really, really strong high-end consumer.
Great. So you kind of hinted at this unemployment jobs market.
We've all seen the unemployment numbers go up.
The most recent jobs revisions, you know,
800,000 fewer jobs created than was expected.
But from the other side, what are you seeing from the company side?
Are we seeing layoffs pick up?
Are we seeing signs that they're about to pick up?
What are the boots on the ground see?
Yeah. And we'll dial it back a little bit.
What happened in COVID, the knee-jerk reaction was to fire a lot of people.
Those companies immediately regretted that decision
because a number of people left the workforce.
And so hiring people back for the post-COVID boom was incredibly difficult.
What we heard up until about six months ago was that
management teams were saying, "Even in an uncertain
market, the last thing I'm going to do is let go people.
It's a labor hoarding." What's the term for that?
We don't feel that anymore.
It feels like a much more balanced labor market where management
teams aren't saying they feel an immediate need to reduce the size
of their labor force, but if they had to, really think they would.
So then let's go to the question of what would cause
a management team to start doing those layoffs.
And I'm going to flip this answer a little bit to the inflation question.
Inflation is coming down, that is great news for the consumer.
That's not always good news for a company.
Over the last year, management teams had the ability to
almost unlimited raise prices and not see a demand impact.
And we're seeing what they call price elasticity, which
means that a higher price is causing consumers to
come back, to fall back from their purchase spending.
That leads to a lower top line, revenue
line, and that really compresses margins.
And so when you see this phenomenon of the inability to
push price and margins start to compress, management teams
can only focus on what they can control and that's cost.
And cost management typically leads to layoffs.
So if we have this cycle of prices are no longer rising, the cost of goods is
roughly the same, we can see an environment where management teams will start
to really focus on protecting those margins by taking
costs out of the business in the form of headcount.
In that environment.
So people start to recognize this, they start
to get a little more concerned about their job.
Am I going to have a job in three months?
Am I not?
So I guess the natural extension is tying back to what you're talking
about earlier, is that it has implications for that higher end
consumer and their willingness or ability to spend going forward.
And assuming that's true, are we seeing any signs of that already?
Sure. It's funny you ask that because Marriott was
asked that exact question this earnings season.
They pointed out that the higher end consumer continues
to show real resilience and real appetite for travel.
They said that they're not seeing this sluggishness
from the lower end creeping to the higher end.
But at the same time, they shared that the consumer is being more judicious
about the fancy dinner or going on that extra trip while they're on vacation.
All right, great.
Thanks for that.
So what's, if there's a base case, what do we
think about the consumer going forward from here?
The consumer is at a wait-and-see state right now.
There's a train of thought that states that the consumer is halted given the
uncertainty created by all the moving parts of the macro, meaning consumers are
waiting to see how the elections play out, whether rates are coming down, what
will ultimately happen with the Middle East, et cetera, to see how they react.
Yeah.
And I just say, if you think of what happened just in the last
four weeks, we've had a former president almost be assassinated.
We've had the Democratic Party replace their candidates.
We've had interest rates in the US come down by 50 basis points.
We've had the stock market sold off 5% and then
recovered 5%, both those in a straight line.
There's just a lot of moving pieces.
And our fear is that all of this noise will cause a pullback
in the high end consumer and their confidence levels.
So that's our base case is that the trend we've seen in the
last quarter or two will ultimately start to bleed up into the
high-end consumer, buffeted by a lot of this macro uncertainty.
Great.
I think that's a good overview of the view of the consumers.
Let's end with a basic question.
So what are we doing about it?
What does this mean for portfolio strategies,
both from an issue or a sector standpoint?
What are we doing about the outlook?
Yeah, I think, as you know, our base case has been that the curve would start
to normalize with overall rates coming down to a less restrictive zone.
We still believe that to be the case.
We also believe that the Fed, you know, the question
we get a lot from investors is, "Okay, great.
Well, if rates are coming down, doesn't that solve all the problems?"
It's helpful, but we think that's going to come with a lag.
And so that's why, even with price moves as they are today,
we're maintaining our positioning at the macro level.
When it comes to credit specifically, we're in a very defensive position.
One, because of our outlook of how the consumer might slow the economy down.
But two, overall credit spreads are very, very tight on a
historical basis, which makes it easier to be underweight.
When you look at the positioning in the portfolio, it's kind of a classic
defensive positioning, underweight consumer cyclicals, underweight, you
know, commodity-type sectors, and overweight more defensives
like utilities, pharma, telco cable, things like that.
So we are waiting for a time when credit spreads will widen for better
reentry, but think that we're heading into a choppy period here.
Great. Thanks very much for your insights.
Appreciate your time.
And thanks everybody for joining us on TCW's Investment Perspectives podcast.
For more information on TCW strategies, please visit our website at tcw.com.
Thanks for listening, and we'll pick up next time exploring
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