Consumers are still spending, but they’re under pressure. These stocks still have room to run
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Seemingly undefeatable U.S. consumers have been propping up the broader economy and staving off near-term fears of a neck-deep recession, but moving forward, their shifting preferences bode well for value and experiences. Persistent inflationary pressures have led to depressed levels of consumer spending all year, according to Bank of America. But there’s a mixed picture. Consumers are still spending — in fact, they’re spending more than they are earning — as employment levels and hourly wage growth remain fairly strong . And this disposable income is largely going towards consumers’ everyday needs and selective discretionary purchases, even as credit card debt reaches 20-year highs, student loan repayment begins and higher everyday prices continue to weigh on the shopper. “The yin and yang is that the consumer is still healthy, but they can’t spend money on big-ticket items because they can’t borrow,” Neuberger Berman senior portfolio manager Steve Eisman, the investor who called the subprime mortgage crisis, told CNBC on Thursday. “The part of the economy that I think is the most worrisome right now is anything that’s a large ticket that the consumer needs to borrow to buy — so, house, auto, solar panel, etcetera.” While consumers might not be looking to buy homes amid record-high fixed mortgage rates and tightening bank lending standards, other sectors are faring well. Think restaurants and general merchandise. Still, post-pandemic spending on apparel, furniture and home furnishings have declined, Bank of America said. Meanwhile, October’s consumer confidence report showed more individuals are planning a vacation within the next six months, which implies there’s ongoing demand for experiences despite signs of spending fatigue, LPL Chief Economist Jeffrey Roach said. This activity supports a consistent theme this year, that the American consumer is often choosing to treat themselves with the occasional splurge while saving where they can. Consumers are reorganizing their “bigger-ticket spends to give [themselves] these mini wins, these tiny luxuries,” said Adrienne Yih, Barclays’ managing director and consumer discretionary analyst. “The consumer doesn’t want to, in a macro environment, go dark. They don’t want to live a very fiscally austere life,” Yih said. “They still want to treat themselves, but they’re treating themselves with more decision-making and in a more mindful manner. The best companies win.” According to several analysts, the winners include value-oriented and off-price retailers, travel and hospitality names and cosmetics retailers. No return to ‘ gluttony of spending’ Shoppers are straying away from luxury items, but are still stretching their thinned wallets for affordable, and often branded, items. Off-price retailers such as TJX Companies and Ross Stores — which cater to the middle-income shopper and more value-seeking buyers — will benefit from this trend, according to Barclays’ Yih and Randy Hare, director of research at Huntington National Bank. Shares of TJX are up more than 14% for the year, while Ross has gained about 4.5%. Analysts covering the stocks love them, rating both companies overweight with average price targets that imply as much as 10% upside for TJX and about 6% for Ross, according to FactSet. “Even the most affluent consumers have middle class spending values,” said Polly Wong, president of marketing agency Belardi Wong, which works with more than 400 direct-to-consumer brands across the country. “I don’t think we’re ever going back to this kind of gluttony of spending” seen during the pandemic. James Lewis, portfolio manager and senior research analyst at Bartlett Wealth Management, and Huntington’s Hare both pointed to Walmart and McDonald’s as beneficiaries of shifting consumer behavior. The stocks are positive for the year, with Walmart hitting an all-time high on Friday to bring its gains this year to about 16%. McDonald’s has edged higher by 1.7% over the same period. While middle- and higher-income customers have turned to Walmart as a refuge from inflation, McDonald’s, which Bartlett owns, has also noted a shift in its own customer base. McDonald’s Chief Executive Chris Kempczinski said in an earnings call Monday that its lower-income consumers, who take home an average of $45,000 a year or less, have particularly felt more price pressures and were negative industry-wide. Still, the restaurant chain saw a boost in third-quarter U.S. sales from higher menu prices. “Retailers that offer a strong value proposition will be the ones that will excel,” Lewis said. “I do think that middle and upper-middle [consumers]…they’re willing to trade up but, you know, they’re keeping an eye on their wallet.” Urban Outfitters and Gap are Yih’s favorite picks over the next 12 months. She anticipates big moves ahead for the stocks as they benefit from changes the companies have made to improve their businesses. This will serve as a catalyst for the stocks despite a declining macroenvironment. Gap is closing hundreds of North American Gap and Banana Republic stores by year-end and it has a new CEO at the helm . Urban Outfitters has strong brand options for a variety of shoppers, such as its Anthropologie retailer, which is succeeding in full-price selling, and its Nuuly’s rental clothing service, which is becoming profitable within the next couple of quarters, according to Yih. Teen apparel retailer American Eagle Outfitters could also be a strong pick in the near term, the analyst said. Gap, Urban Outfitters and American Eagle have seen their share prices soar this year — gaining nearly more than 24%, 50% and 33%, respectively. Some analysts see an opportunity to pick up shares of battered-down retail stocks. “The sell-off in retail stocks over concerns about student loan payment redemption and higher-for-longer interest rates are overblown and it’s created a number of attractive buying opportunities, including Ulta Beauty , Savers Value Village and National Vision ,” Loop Capital managing director Anthony Chukumba said, adding that the consumer is propped up by a strong employment market and wage growth, allowing consumers to continue spending. This steady sell-off in consumer stocks since early August, despite hotter-than-expected U.S. retail sales in the past two months, indicates that softening macroeconomic trends are priced into many retail stocks, Chukumba wrote in an Oct. 18 note. Shares of Ulta are down 18% for the year, while optical retail company National Vision has plunged roughly 56% during the same period. Savers Value Village, a secondhand goods provider, has shed nearly 15% so far this quarter. These names have either seen significant share declines in the last couple of months and/or are trading at significant discounts to their historical 10-year averages, according to Chukumba. Similarly, Yih believes an uncertain macro backdrop can provide unique investment opportunities in long-term strong brands and secular winners, such as Ulta and lifestyle and sports retailers Nike and Lululemon . Wells Fargo analyst Ike Boruchow also has an eye on these retail names, writing in a Wednesday note that the firm has the “most confidence that numbers will head higher” at Gap and TJX, followed by Lululemon and discount retailer Ross Stores . ‘Starving’ for health and wellness Consumers may be skimping on a fresh winter wardrobe this season, but they’re not looking to skip on vacations. While they are strapped for cash, individuals are also “starving for their health and wellness,” Kathleen Entwistle, managing director at Morgan Stanley Private Wealth Management, said. Investments in travel, leisure and areas of health care, such as cosmetics and nutrition, are the purchases many consumers are eyeing. “After Covid, I think everybody just needs more stress reduction, more taking good care of themselves, and they’re willing to do some of that with travel,” Entwistle said. “They want better sleep, they want better nutrition, they want better fitness, they want better mindfulness, better appearance.” Asset management firm Citizens JMP Securities highlighted a slew of travel-related stocks that could benefit. “Travel demand remains robust despite ongoing macro turbulence,” the firm said in an Oct. 12 note, saying that while consumer confidence remains below pre-pandemic levels, domestic and foreign travel intent was above 2019 levels by the end of August, suggesting individuals are making discretionary spending cuts in other sectors. JMP assigned an outperform rating to online travel agency Booking , saying it is “best-positioned to withstand macro headwinds given its resilient upper funnel trends, U.S. share gains, and robust international business,” according to an Oct. 12 note. The firm also highlighted Vacasa , expecting the vacation rental management company to return to “sustained top-line growth” in the near term, and highlighted Delta Air Lines ‘ strong earnings and fourth-quarter guidance. Expedia is a buy-rated travel name from Deutsche Bank, which maintained its buy rating and $118 price target on the company, implying shares could gain 4.7% from Friday’s closing price . The bank said it expects Expedia’s third-quarter volume to be in line with expectations and bookings to accelerate in the fourth quarter. LPL’s Roach added that hotels stand to benefit from increasing travel demand, particularly as the rate of revenue per available room — a key metric for the hospitality and leisure sector — is growing at a solid pace as hotels pass along their higher labor and commodity costs to consumers. ‘Leftover juice’ Spending in certain sectors may currently be holding the economy afloat, but some analysts believe a pullback may be due next year. Morgan Stanley’s Entwistle said she expects nearly a quarter of the population will see their household finances worsen over the next six months, with consumers spending less and prioritizing essential categories like groceries and household items into next year. Already, she has noticed a rise in late credit card payments. “We had a lot of leftover juice, leftover cash or opportunities to spend money that we still felt comfortable enough in the beginning half of the year, but in the second half of the year, I think we’re starting to see some of those cracks,” she said. “People just want to be more conservative and they want to protect their financial foundation. According to Barclay’s Yih, spending levels “almost have to be worse” next year. LPL’s Roach similarly expects consumers spending to hit a roadblock in the coming months. “Our expectation is that the spending splurge is going to end soon, perhaps starting to really show up in earnest as a pullback in spending in 2024,” Roach said. “But, at this point, it really doesn’t look like the end is quite there yet.”
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