US consumers have often been the not-so-secret weapon for the US economy. They have spent their way out of trouble, supporting growth and reviving the economy when it has been most needed. However, could this fabled strength be about to become a weakness?
In the US, private consumption – or consumer spending – is important. Estimates suggest that it accounts for around 68% of Gross Domestic Product (GDP). Today, this is nearing the record high levels set in 2011, where it reached 69% of GDP. It was a primary engine of growth in the second quarter of 2023, rising 1.6%. It has been a key driver of the jobs’ recovery.
However, there are signs that this strength may be starting to roll over. The current consumer confidence has its roots in two areas: the savings pot many investors built up during the pandemic, and strong jobs growth and there are signs that both are weakening. On The North American Income Trust, we are keeping a close eye on the data as it emerges.
Pandemic savings, spent
Around $2.1 trillion in excess savings was accumulated over the course of the pandemic, as the Government distributed cash to protect households. This had dwindled to around $500bn by March of this year and by June, only $190bn remained. Where those savings remain, they tend to be concentrated in the highest quintile of households. Perhaps this is why a recent report from McKinsey showed optimism about the economy highest among baby boomers, but plummeting among millennials.
The US has now largely exhausted its ‘you only live once’ summer of spending, and will shortly have to return to reality. There are some cracks appearing in consumer spending data. While we see many companies maintaining margins, increasingly this is at the expense of volumes. It is likely to become difficult to sustain this situation indefinitely. Consumers have a tipping point.
Buoyant labour markets
That said, most Americans still have jobs. The American model of consumption is such that while the jobs market remains buoyant, so does consumption. Until there are real difficulties in the labour market, consumption may hold up. The question is whether that weakness is starting to emerge. After all, the goal of the Federal Reserve in raising interest rates has been to calm the jobs market sufficiently to bring prices lower.
Jobs growth has levelled off in recent months. In September the economy added another 336,000 jobs, well above the pre-pandemic average, but new job openings are starting to drop. Wage growth has cooled to a more modest 4.2% year on year, while the unemployment rate appears stable at 3.8%. This would appear to suggest a discernible cooling in the labour market, even if we don’t expect a significant downturn.
Selective consumer holdings
What does this mean for our investment strategy? Unsurprisingly, the US consumer is also a significant part of the US stock market – around 17% for our benchmark index, the Russell 1000 Value. While we are significantly underweight the consumer discretionary sector and, to a lesser extent, the consumer staples sector, there are still opportunities. Even if the US consumer turns lower, there are still plenty of Dollars to go after.
Our solution has been to ensure that we are focusing on those companies that have something extra. Walmart and Procter and Gamble are large index constituents and we hold neither. They are large, well-run mature businesses, but are unlikely to deliver significantly ahead of retail sales. On the other hand, there are businesses such as Restaurant Brands International, which has been through a difficult period, seen significant under-investment, but now has a new chairman who has come in from Domino’s Pizza and is making changes. It could see an expansion of sales, margins or its multiple as a result. These idiosyncratic opportunities are important at a time when growth becomes scarce.
Equally, within the consumer segment, there will be specific areas of structural growth. We hold Keurig Dr Pepper, for example, which has a significant and fast-growing coffee business sitting alongside its mature soft drinks business. There are a number of consumer groups who have fast-growing businesses in emerging markets, which can support more mature businesses elsewhere.
It is possible to find high quality, cash generative businesses with the potential to grow their dividends even in unpromising sectors. There may also be mispricing. We do not underestimate the power of the US consumer but recognise that this is a moment to be selective.
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Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.