Tapped Out and Teetering
Is the American consumer about to break? Dissecting retail results, interest rate impacts, and savings data to understand today’s consumer spending weakness.
Recent economic data has begun ringing alarm bells across the capital markets, as a pronounced slowdown in consumer spending takes center stage. Retail giants, economic indicators, and financial headlines are increasingly painting a picture of a U.S. consumer that's stretched far too thin - and what that means across the economy is interesting to think about.
Given that consumer spending accounts for roughly 70% of the U.S. economy, understanding whether this slowdown is temporary or indicative of deeper issues is critical for market participants.
Check out this chart below. Investors often look at the SPDR S&P Retail ETF (XRT) as a reliable proxy for consumer sentiment. XRT includes a diversified basket of retailers across various segments—from discount chains to specialty apparel and electronics stores. Because it broadly represents consumer discretionary spending patterns, tracking XRT's performance can provide valuable insights into the health and confidence of the American consumer, reflecting shifts in spending behavior and overall economic sentiment.
What's Behind the Slowdown?
Several interconnected factors contribute to the current moderation in consumer spending. While the macroeconomic picture is nuanced, a handful of persistent pressures are especially pronounced:
Persistent Inflationary Pressure
Although inflation has moderated significantly from its somewhat recent highs, prices for core necessities such as groceries, housing, and fuel remain elevated. Have you been to the grocery store lately!?
Even modest inflation, if prolonged, gradually erodes purchasing power, forcing consumers to alter spending habits. Many households, particularly those with lower incomes, find themselves allocating larger portions of their budgets to basic necessities, leaving less room for discretionary spending. This sustained inflationary environment creates uncertainty, prompting consumers to adopt cautious spending behaviors, prioritizing essential purchases over discretionary ones.
Consumer Credit and Rising Interest Rates
Another critical issue currently facing consumers is the environment of higher interest rates. The Federal Reserve's aggressive tightening cycle has significantly impacted credit affordability, causing higher interest payments on existing debt. Credit card balances and delinquency rates have risen noticeably, reflecting stress among borrowers. Auto loans, mortgages, and personal loans have become significantly more expensive, directly impacting consumers' ability and willingness to make large purchases. Consumers who once relied on low-interest borrowing are now forced to reconsider or postpone major spending decisions, contributing further to economic sluggishness.
Savings Depletion and Financial Stress
During the pandemic, stimulus checks and reduced spending opportunities led to unusually high savings rates. However, recent data indicates that these accumulated savings have now largely dwindled. Household savings rates have returned to historic lows, around 3-4%, indicating that many consumers no longer have a cushion. This depletion makes households increasingly vulnerable to economic shocks, further contributing to reliance on credit. The exhaustion of pandemic-era financial buffers means that any additional economic stressors could rapidly translate into further consumer distress and spending contraction - which we’re already seeing.
Sector-Level Insights
Retail: A Tale of Two Consumers
The retail sector reveals a pronounced divergence. Discount retailers, such as Walmart, Dollar General, and Costco, are seeing steady traffic, but even their customers have become increasingly price-sensitive, shifting to private-label goods and essentials. Premium retailers and discretionary brands, such as Nordstrom, Macy’s, and Lululemon, are struggling as consumers cut back on non-essential purchases, showing early signs of potential trouble in the consumer discretionary space. Nike recently reported increased promotional activity and weaker sales in North America, indicating broader pressure within apparel.
Travel and Leisure: Mixed Signals
The post-pandemic boom in travel and leisure appears to be losing momentum. Airlines like Delta and American Airlines, cruise operators like Carnival and Royal Caribbean, and hotel chains including Marriott and Hilton initially enjoyed a resurgence in demand, but recent trends suggest moderation. Consumers remain eager to travel, but spending patterns indicate shorter stays, budget-friendly accommodations, and more deal-seeking behaviors. Airbnb’s recent earnings highlighted increased price sensitivity among travelers, pushing hosts toward more competitive pricing strategies.
Housing and Auto Market Pressures
Interest rate hikes have particularly affected the auto and housing markets. Auto loan rates reaching multi-year highs have significantly dampened consumer demand for new vehicles, and dealers, including CarMax and AutoNation, report bloated inventories and rising incentive spend. Similarly, the housing market has experienced a dramatic slowdown, impacting homebuilders like Lennar and D.R. Horton, as high mortgage rates keep many potential homebuyers sidelined. Existing home sales continue to soften, and builders are scaling back new projects, potentially dragging on broader economic growth. Home Depot and Lowe's have noted a slowdown in renovation spending as homeowners tighten budgets.
Insights from Retail Earnings Reports
Recent quarterly earnings calls provide deeper insights into consumer behavior:
Target - The company highlighted notable weaknesses, particularly in apparel, home goods, and electronics. Management noted that shoppers are clearly prioritizing essentials over discretionary items, leading to heavier discounting and inventory clearance strategies that negatively impact margins.
Walmart - Walmart’s grocery-driven strategy continues to provide resilience, though management stressed consumers' increasing focus on value and essentials. CEO Doug McMillon indicated shoppers are trading down to private-label goods, reflecting a defensive posture amid persistent economic uncertainty.
Amazon - Amazon reported steady sales in core essentials, driven by its diverse product mix and convenient shopping experience. However, the company highlighted increasing price sensitivity among consumers, with shoppers shifting toward lower-priced alternatives. Amazon is increasingly using targeted promotions to maintain consumer engagement.
Best Buy - Best Buy emphasized that consumer demand for electronics has sharply contracted, with consumers delaying larger discretionary purchases like TVs, appliances, and high-end computing equipment. Management indicated caution moving forward, forecasting continued pressure on revenues and profitability.
Dollar General and Dollar Tree - Both retailers reported increased foot traffic as consumers seek budget-friendly options amid economic pressures. However, they also flagged significant margin pressures from rising operational costs and increased promotional activity. Executives expect these headwinds to persist, requiring careful margin management and cost controls.
Investment Implications
Discount retailers and companies providing essential goods, such as Walmart, Dollar General, and Costco, are poised to outperform if consumer sentiment returns. These companies offer relative stability and predictable cash flows even in a strained consumer environment. Conversely, premium retailers and discretionary sectors warrant caution, as declining consumer confidence may continue pressuring earnings. Companies such as Lululemon, Nike, and Macy’s face heightened risk amid continued consumer caution.
Firms heavily reliant on consumer finance, particularly subprime credit providers like Ally Financial and Synchrony Financial, could face increased default risks, harming profitability and stock performance.
I believe that the current slowdown in consumer spending appears to be more than a short-term dip. Persistent inflation, higher interest rates, dwindling savings, and increasing credit burdens suggest consumers face structural challenges that could suppress spending for an extended period.
What a weird and wonderful world,
Quick PSA
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