Shop till you drop? What the holiday season tells us about US consumer health

Following on from our previous  blog  that highlighted our thoughts on the current US earnings season, we turn our attention to the upcoming holiday season and the health of the US consumer. 

Looking at some of the recent retailer earnings we have concluded that the path ahead may prove difficult for many of these US retailers given many have reported good third quarter earnings but painted a gloomy picture for the 2024 fiscal year. Considering that private consumption expenditure (PCE) accounts for roughly two-thirds of gross domestic product (GDP), this holiday season will be an important litmus test to help determine the current health of the US consumer, as well as providing some meaningful guidance for GDP growth projections over the next few quarters. This, in turn, can provide some insights as to what the future path of Federal Reserve monetary policy could look like. 

We can begin by looking at the latest retail sales numbers. Going back to the most recent data for October, we saw month-on-month retail sales much lower than September, albeit slightly higher than forecasted. Adjusted retail and food services sales declined 0.1% (slightly above consensus of -0.3%) on a month-on-month basis, which was much lower than September's increase of +0.9% [revised from 0.7%]. 

The retail sales control measure rose 0.1% in line with consensus, but the previous month was revised up 0.1% to 0.7% thereby showing a sharp decline month over month. This is a more precise measure of gauging consumer spending as it represents the total industry sales that are used to prepare the estimates of PCE for most goods. Although modest, the increase in the retail control measure was mostly due to the online and food components. Online sales rose 0.2%, which was a marked deceleration from the 0.8% average month-to-month increase in the first three quarters of the year. Interestingly, the market reacted well to these numbers as they really came in at or slightly better than consensus. But the trend was beginning to show signs of strain.
 
This turn of sentiment can be highlighted by some of the recent comments made by corporate retailers and their short-term projections. For example, Walmart, the largest US retailer, whose performance is closely followed as a measure of the mood of the American consumer, cautioned that "growth would moderate in the holiday quarter after experiencing a softening of sales in the second half of October as consumers shift their spending away from discretionary items". 

Department stores have been hit especially hard. Macy’s comparable sales were down nearly 8%, Bloomingdales were down 3.2% and Nordstrom reported a 9.4% fall in net sales. We found similar warnings from some traditional retailers, such as the likes of Kohls and Target, to name a few. Shoppers are finally feeling the effect of higher inflation and a lot of the retailers are bracing for a bleak holiday season. Interestingly, not everyone will be a winner on Black Friday but off-price retailers, such as TJX and Burlington who reported comparable store gains of 6% seem to be benefiting as the trend moves from department stores to more discount pricing outfits. 
 
This leads us to Black Friday and Cyber Monday. According to Adobe Analytics, Black Friday online sales came in at $9.8bn, up 7.5% over last year’s numbers, and Cyber Monday spending reached $12.4bn, which represents the biggest online shopping day of all time. An important factor has been the increase in buy-now, pay-later options and is an indicator that consumers are mindful of budgets and have been waiting for these bargains. It also provides an argument that shoppers are finally feeling the effects of inflation and higher interest rates. Usage of this option is expected to hit all-time high of roughly $800m [up nearly 19% year-over-year]. One tell-tale sign that retailers have tempered expectations can be seen in their management of inventories. Target, Macy’s, Kohls and Nordstroms are all examples where pre-holiday inventory was down versus the previous year. Sales data have nonetheless been quite impressive considering the sluggishness that retailers are forecasting for the holiday period and over the near term.
 
To conclude, retail sales are one element that contributes to the temperature of consumer sentiment. The University of Michigan preliminary consumer sentiment index for the month of November came in at 60.4 from 63.8 seen in October, while the future expectations index declined to 56.9 (from 59.3). However, we’ve also just seen November data for the Conference Board Consumer expectations index showing slight improvements from October (77.8 versus a revised 72.7) but still signalling softer real consumption growth in the fourth quarter compared to the third quarter. 

Given the overwhelming success of Black Friday and Cyber Monday, is it enough to change consumer sentiment? Clearly most retailers do not believe this optimism will continue. Although discounted prices and inventory management have proven successful for the most part, concerns persist about the strength of spending particularly on discretionary items. Signs still support a resilient US consumer, but some cracks are forming. This deceleration in consumption is consistent with growth slowing down in the fourth quarter and the next few quarters. 

A softish landing remains our base case, which would allow the Fed to reverse some of the hikes in 2024. Given where yields are we think this a good environment to generate attractive returns in fixed income.