Ruminations on Consumer Spending: Do Not Disturb the Water

There is a wonderfully masterful scene in The Lord of the Rings: The Fellowship of the Ring, where Aragorn silently warns, "Do not disturb the water".

You may recall from that movie moment that Merry and Pippin are blissfully and ignorantly hurling stones at the water, oblivious to awakening the imminent danger lurking beneath.

In some ways, it feels as though investors and corporate management teams alike are acting a little like Merry and Pippen these days, ignoring some growing warning signs that the consumer is weakening.

A Losing Battle? Don't Follow the Lights

No doubt, betting against "the consumer" has been a losing battle over time. The sustainability of aggregate consumer spending in the face of a hawkish Fed and rising rates has surprised most (including me).

But simplistically looking at the aggregate data alone from the top of the mountain is a bit of a ruse and tells a different tale compared with that told by the working-class folk at its base.

First, assuming you believe the unemployment rate data, the average worker is seemingly able to find jobs today, and it is always easier to spend money when you have consistent income (or at least feel confident that you can obtain it).

The irony is when I talk to people who are currently employed full-time, more and more of them are unhappy with their work and/or compensation and actively looking for a new job, making competition for available jobs unusually high for a time where employment trends are historically strong. All you have to do is check the job applicant counts on LinkedIn to realize how quickly new job postings are being hit.

This decline in job sentiment is statistically borne out from the latest job satisfaction data from The Conference Board, where across all 26 subcomponents, there was a decrease in job satisfaction in 2023 compared to 2022:

I am having more 1x1 conversations these days than at any time in my career with very qualified people who feel stuck in their jobs and careers because they are not even getting interviews. Then there is another subset who are getting worried and frustrated when realizing that post-COVID travel was great and fun, but extended time off and inflation are a bad brew to chug to cure their early retirement hangovers.

So when I process all of that through the mental blender, I just wonder what happens to consumer spending when competition for jobs REALLY ramps up because the focus has shifted from changing jobs to, well, obtaining one.

The second point to make in this analysis is that the consumer continues to increasingly bifurcate. This is not new news. As a result, the wealthy drive the aggregate numbers we see in the headlines (thank you, Mr. Stock Market and Mr. Real Estate Market). Meanwhile, lower-end consumers who are not there struggle more and more with a higher cost of living. The irony of this situation is that one could argue that the wealth effect is causing inflation for the average consumer because it is artificially filtering down into higher demand for everything. In economic terms, the wealthy have a much more inelastic demand curve than those in lower-income brackets. Sadly, trickle-down economic theory says nothing about inflation for the masses.

It makes one wonder if the Fed needs to more actively target stock market inflation with monetary policy. Or perhaps a stock market correction is why they are waiting to cut rates? Hmmm...

Debt: One Ring to Rule Them All

Indeed, the rate of inflation thankfully is much more reasonable today versus two years ago, which is certainly something to celebrate. While this "decline" is helpful, keep in mind that the cost of living is still rising at a level above the Fed's target rate, and off of a much higher base now.

Put another way, your grocery bills are much higher than they were a few years ago, and are probably never going back to those prior levels. If you are struggling to pay higher bills across your entire way of life today because of inflation, good luck, because that is not likely to change just because the Fed magically hits its inflation target of 2%.

Sam : It's the Ring, isn't it? Frodo : It's getting heavier.

So if this cost-of-living albatross around their neck isn't going away any time soon, how are average consumers still spending money? It is a jobs-first, and debt-financing second answer. It is certainly not about savings:

This growing consumer debt burden is also coming at a very high cost: Personal interest payments have skyrocketed at a pace not previously seen in the history of the data set:

Directionally, this increase in interest payments should not be surprising given how much interest rates have risen over the last couple of years. But the absolute level of interest expense burden by the consumer today is staggeringly large considering we are hardly at unprecedented levels on the Fed Funds rate.

Put another way, prior to the financial crisis of 2008-09, the Fed cranked up the Fed Funds rate to about the same levels as today, and yet we did not see anywhere near the levels in personal interest payments that we are seeing today.

The conclusion: the mainstream consumer is struggling to make ends meet despite the strong headline jobs and economic data. What happens when more people actually start losing jobs?

How does consumer credit look so far? Thankfully, the absolute levels of consumer loan delinquencies are still quite benign relative to history. But it is worth noticing that the rate of increase has been rapidly accelerating recently — again, even while unemployment remains at historically low levels. Is this just "normalization" of credit, or is this another early warning signal about consumer health?

There is unfortunately more data to suggest it is more the latter than the former. For example, the data below sourced from the University of Michigan consumer sentiment surveys suggests there has recently been rapidly growing concerns by consumers about their income security in the coming year. This could also lead to more hunkering down and less discretionary spending than currently expected by Wall Street, especially in a period where the average consumer appears to be spending beyond his/her means already:

Another correlating change lately has been the results of some well-known consumer companies, which appear to be telling a different tale of late than in prior years, including disappointing results this year from MCD, SBUX, TGT, NKE, DLTR, LULU, ULTA, and TSLA, among others. These stocks have certainly underperformed individually this year, but it is also interesting to see how the overall Consumer Discretionary Sector SPDR ETF (XLY) has also been lagging the overall S&P 500 (SPY) in 2024. This is especially noteworthy since this generally has not been the case over the last decade:

These data points tell the tale of the consumers' adventure, burdened by borrowed money and borrowed time — a time of historically strong employment. It will be important to watch these data points evolve in the coming quarters as employment trends unavoidably weaken.

Why care? Despite the generative AI mania of the day, the consumer is still incredibly important to getting the economy and the stock market call right. GDP is still two-thirds driven by the consumer. It is hard to point to when or if the danger that lurks beneath will turn on financial market constituents, but I would not dare disturb the water if labor market trends continued to deteriorate further nearer term.

If economic cycles are still a thing, recently rising jobless claims are just starting for this cycle. The data in this article suggests the average consumer is not nearly as well positioned as they should be at this point in the cycle, and ever-more sensitive to being just one job loss away from much more significant financial burdens.

All commentary in this article represent my own personal views, opinions, and analysis, and are not representative of those of my current or past employers, nor intended to do so. None of my comments are intended as or should be viewed as personal investment advice, nor am I compensated to provide any of the commentary above.