Morgan Stanley
  • Wealth Management
  • Aug 24, 2021

How Strong Is the U.S. Consumer?

A closer look at the weaker-than-expected economic readings fueling concerns about slower spending and growth suggests opportunity for investors.

U.S. consumer confidence plunged earlier this month, with the University of Michigan’s consumer sentiment index falling from 81.2 in July to 70.2 in August—the lowest level in almost a decade. Then, a rash of weaker-than-expected economic data, including in retail sales, followed.

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Consumer spending makes up about 70% of all U.S. economic activity, making retail numbers a closely watched indicator. The latest data appear to have reignited a “growth scare” narrative among investors concerned about dimming prospects for the U.S. economy. As a result, volatility returned to markets recently, and major indices have posted back-to-back declines, with cyclical stocks unwinding yet again and consumer-linked names especially punished.

The main culprit: the highly contagious and fast-spreading Delta variant, which is reshaping the economic recovery and could delay certain measures of projected growth by several months. But that alone isn’t cause to question the economy’s overall trajectory. Before embracing the alarmist view that the consumer will crumble under the negative sentiment around Delta and the expiration of U.S. government benefits for those most impacted by the pandemic, investors should focus on the broader context.

And what does that mean?

While the latest consumer readings have been described as “disappointing,” they still show that purchasing remains 17% above the pre-pandemic February 2020 data. It’s a good reminder of how consumers have navigated the pandemic so far. The sheer size and speed of government benefits at the start of the crisis—and the household propensity to prioritize everyday-goods purchases—resulted in extraordinary levels of personal savings. As these funds were drawn down, retail sales recovered aggressively. In fact, consumption of goods, in the absence of a full recovery in services, has grown unsustainably high and will almost certainly revert to average levels over time.  

The latest manufacturing statistics reflect strong ongoing demand for goods. In July, manufacturing activity jumped to 76.6% of capacity, moving past pre-pandemic levels; industrial production rose a better-than-expected 0.9%, aided by an 11% jump in motor-vehicle production—the most in a year. Durable-goods orders have been rising as well, suggesting that inventory restocking is nowhere near complete. This data indicates that the bearish view of an imminent collapse in goods-consumption seems too bleak.

Ultimately, the labor market recovery will prove a key driver for sustained strength in personal spending, and by extension U.S. gross domestic product. On this point, we are unequivocally bullish. Labor market dynamics look strong. The Conference Board’s Employment Trends Index shows continued positive momentum in employment conditions. The number of job openings is at all-time highs, and wages are growing. While the pace of employees’ return to their offices may slow, for example, due to possible delays in school reopening, at this point, we don’t anticipate widespread disruptions.

In sum, we believe that the overall backdrop for consumers is among the best it has been in decades, with record-low ratios of debt to total net worth, still-ample savings, a supportive job market and banks eager to extend credit. Given that the S&P 500 continues to look overpriced, recent market turbulence may be an opportunity for investors to be selective among consumer-services stocks, which could benefit from pent-up demand for a sector that hasn’t fully reopened. In particular, consider financials, health-care and housing-linked companies that have quality cash flows and fair valuations.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Aug 23, 2021, "Consumer Slowdown?" Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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