Watch what consumers do, not what they say

Ajay Rajadhyaksha is the global chair of research at Barclays. Here he argues that the markets are too concerned about consumer-led recessions.

For months the markets have been anxiously waiting for the answer to the question: how is the western consumer doing? Indeed, in many countries, consumption accounts for more than two-thirds of activity, and consumers have been hit hard in recent times.

The answer seems pretty clear.

Food and gas prices exploded after the Russian invasion of Ukraine. Energy inflation is rampant in Europe; German energy costs rose 35 percent year-on-year last month. Country after country, grain exports are slamming shutters as prices skyrocket and food security becomes an existential threat to regimes. (Last week India banned all wheat exports).

This is a big slap in the face for many households. Despite all the talk of a labor shortage, wages are not keeping pace with inflation. Wages in the US are 5-5.5 percent, while inflation is currently 8.3 percent. Europe lags even further behind; Spanish inflation is at 10 percent, while wage increases are less than 2.5 percent.

And it could get worse. Russian natural gas still flows to most of Europe; but that could change. If the planting season in Ukraine and Russia is affected, the world will struggle to feed itself in the coming months.

So yes, there isn’t yet a swarm of locusts on the horizon, but everything else that can go wrong has.

No wonder Western consumers are in a gloomy mood. Survey after survey shows their confidence is at its lowest level in decades. US consumer confidence has deteriorated to its lowest level since mid-2011. German consumer confidence is now below May 2020 as the nation was reeling from a prolonged Covid lockdown. In the UK, consumer confidence is now at its lowest level ever since measurements began in 1974.

Line chart of the index showing consumer confidence in the UK has fallen to an all-time low

With such soul-crushing doom and gloom, it seemed only a matter of time before Western consumers would turn off the lights, pull their blankets over their heads and stop spending. That time now seems to have arrived.

Several major US retailers announced their first quarter profits last week, which was not a good thing. Walmart and Target lowered earnings expectations and complained of weaker consumer demand, especially for higher-margin items. Of course, there were also some missteps by management, but investors did not linger for a second look: they fled en masse.

Walmart and Target both had their worst trading days since Black Friday of 1987. These were moves you would normally see in crypto, not big boring staple retailers.

Line chart of stock price ($).  with major retail stocks puked last week

More tellingly, the damage extended beyond these companies. The S&P 500 fell more than 4 percent and the Nasdaq nearly 5 percent, respectively, their worst trading days for 2022. In market spirit, the results finally seemed to confirm what investors feared since the beginning of the year: Consumers are finally the problems, and a recession is imminent.

Not so fast. It’s a nice theory, all wrapped up in an arc. And yet, the aggregated data just doesn’t confirm it.

Early last week, just as Walmart and Target reported, US retail sales surprised positively, including strong revisions for March. UK retail sales rose 1.4 percent in April, even as consumer confidence plummeted. And European surveys of purchasing managers were surprisingly strong in April. Consumers love to tell to us they feel terrible, and they have a good reason for doing so, but crucial they still spend

What is happening? Why does consumption remain stable despite so much headwind? Because there is also a tailwind.

First, unemployment rates are at or near record lows in both the US and Europe. Yes, real wage growth is negative for now, but pretty much everyone has a job – that’s hugely positive.

Line chart of the unemployment rate (%).  show Unemployment is low and falling

Second, Western households have loads of excess cash — money they didn’t spend on services during the Covid-hit years 2020 and 2021. The numbers are great; For example, U.S. households have several trillions of dollars in savings above what they would have had if Covid had never happened. And they seem willing to dive into these savings for fuel economy, even if real income takes a hit.

Third, there is the changing nature of consumption. Now that we are coming out of the pandemic, service activity is increasing. We eat out more, take those vacations we never did in 2020 and 2021, and resume business trips. Sadly, sales analysts are once again being sent around the world (I’m writing this piece on a work trip in Asia). There is currently a tourist boom going on in the US and Europe.

We will be spending fewer dollars on goods this year, especially given the shopping spree most of us went through in 2021. This shift of goods is likely to disproportionately damage companies that make or sell those goods, which are usually the big companies we see on the list. at the fair.

Line chart of the S&P 500 index showing US stocks sinking into a bear market

But it’s not indicative of overall consumer withdrawal. Instead, we spend more but in places like the local restaurant, the hair salon nearby, and on that family trip.

This is not an argument for unbridled optimism. One place where consumption takes a huge hit is China, as the zero-covid approach impacts activity. Financial markets everywhere are creaking and central banks are unmoved – no recipe for cheering the consumer’s mood.

But a consumer-driven recession in 2022 remains highly unlikely, at least in the US, no matter what stocks seemed to be screaming last week. For now, investors should focus on what Western consumers are doing and ignore what they say.

Leave a Comment