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Written by: Len Reininger | Advisor Asset Management
Much is being reported in the press and the markets that the Fed has successfully navigated the pandemic, torrid inflation and an extremely tight labor force and is bringing us in for a soft landing. And, on the surface, what’s there to argue about? The number of jobs is still growing but at a more measured pace, inflation is decelerating nearing the Fed’s target at 2%, retail sales unexpectedly rose in August by 0.1%, mortgage rates are coming down slowly, and GDP is still growing (currently at a 2.3% rate).
And yet, there is an underlying base of data that reveals that not all is as smooth as the aforementioned headline numbers imply. Many retail companies continue to report negative comparable same store sales blaming consumer weakness. Moody’s just took one of the largest global companies in the world out of investment grade territory, lowering the rating from Baa3 to Ba1 due to “the difficult consumer spending environment.”
Meanwhile, the number of job openings took a step back in July — job openings are in decline with the fewest openings since 2021. Moreover, consumer behavior is changing, and retail sales appear to be driven by growing borrowing and drawing down on savings.
The U.S. personal savings rate as a percentage of disposable income was at 2.9% for July, the lowest since June 2022. The recent, better-than-expected retail sales number appears to be masking growing consumer stress.
Source: The Institutional Strategist
While some may argue that the dip in the personal savings rate is evidence of strong consumer spending, this is not borne out by the fact that there is also rising retail inventory levels, which will increase margin pressures for certain retailers. Retailer’s inventories continue to increase.
In other words, the drop in the personal savings rate cannot be explained away by the modest increase in sales as sales inventory continues to grow at a faster rate.
Defaults for lower-income demographics could be set to rise given their declining level of assets alongside a highly questionable employment picture (lower job openings, slowing job growth and ongoing downward revisions to previous job growth numbers). Moreover, the drop in consumer liquidity occurs concurrently with a fairly rapid pace of household debt growth.
At the same time, credit delinquencies up to 60 days have risen the most in four years and appear very closely correlated to the more negative outlook for employment and recent labor market weakness.
Auto loan delinquencies are climbing as well and are at the highest level in three years. In fact, a major player in auto lending spooked investors by warning that "credit challenges have intensified" in this business over the quarter. Their CFO told an investor conference that borrowers "have been struggling with cost of living and now are struggling with an employment picture that's worse." He said overdue payments on car loans and charge-offs were higher than expected in July and August, and the company will likely have to increase loan-loss reserves. Additionally, last year's retail auto loans, while faring better than 2022, still face rising pressure amid "an increasingly difficult macro environment."
In fact, on a YoY (year-over-year) basis, every category of loan, except for student loans, saw increasing flows into serious delinquency (90 days or more delinquent).
Job openings are already in decline with the fewest openings since 2021 and multiple job holders remains high and is growing as a percentage of total employed, now at 5.3%, the highest level since the pandemic. When these jobs shed, that is when serious consumer strain will begin, in our view. Another area of potential concern is the trend in full time jobs — we are seeing full-time jobs decline YoY since February 2024.
The ISM (Institute for Supply Management) manufacturing data presented as “stagflationary” again, with input costs now having risen every month in 2024 and at a 16-month high for August, while the headline number remains in contraction. In fact, the ISM manufacturing index was negative for the fifth straight month, signaling the manufacturing side of the economy is still in a deep slump. S&P explained why manufacturing is struggling:
Per S&P, “Slower than expected sales are causing warehouses to fill with unsold stock, and a dearth of new orders has prompted factories to cut production for the first time since January. Producers are also reducing payroll numbers for the first time this year and buying fewer inputs amid concerns about excess capacity…. The combination of falling orders and rising inventory sends the gloomiest forward-indication of production trends seen for one and a half years, and one of the most worrying signals witnessed since the global financial crisis…. Although falling demand for raw materials has taken pressure off supply chains, rising wages and high shipping rates continue to be widely reported as factors pushing up input costs, which are now rising at the fastest pace since April of last year.”
Finally, we have seen recent reports from dollar stores that have hurt these respective companies in the market, both guided sales lower. One stated that their customers now feel worse off than six months ago, with 60% of customers admitting to not being able to purchase basic necessities. As a result, customers are utilizing credit cards more, have at least one card that is maxed out and anticipate missing a bill payment within the next six months. Management reported “immense pressures from a challenging macro environment” that is increasing the effect of macro pressures on the purchasing behavior of their middle- and higher-income customers. On the company’s earnings call, the company’s Chief Operating Officer (COO) said core, lower-income customers remain under pressure. He added that high inflation, interest rates and other economic dynamics also started to have a bigger impact on their middle- and higher-income consumers during the latest quarter. Even liquor companies disappointed the markets with weaker-than-expected expectations as they face a more cautious consumer environment that is more significant than previously forecast.
The markets may be too complacent and confident that the soft-landing scenario will result in a strong, stable, and normalized U.S. economy. There are some worrisome economic undertones that have the potential to derail a benign soft landing. Regardless of any interest rate reductions, we believe the data shows that the consumer could be under some real strain over the next several months.
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