Is the Consumer Slowing? 

By Paul Broughton, Portfolio Manager

We’re now approaching the mid-year point of 2024 with five months officially in the books. The S&P 500 is up 10% year-to-date and the driver of this strong return has largely been stocks associated with artificial intelligence (AI). This has included the AI-related semiconductor stocks, which have rallied sharply based on current and future demand for the powerful computing capabilities needed to enable AI applications. But what about the rest of the market? What can we discern from the numbers so far and what should be aware of?

The performance of Nvidia is truly impressive, up 120% year to date. Its most recent quarterly report was exceptionally strong, but the surge reflects more than just a single, strong quarter. The company’s trailing twelve-month revenues of $79.8 billion were more than triple its level just one year ago, $25.9 billion! And the stock’s valuation still looks fairly reasonable at 36 times the next twelve months of earnings once noting the company’s earnings growth forecast of 105% for this year and 30% next year. By contrast, note that the S&P 500 is currently trading at 21x with earnings forecast to grow at 11% and 12% over the next 12 and 24 months, respectively. A recent addition to the S&P 500, Super Micro Computer, has been another strong performer this year, which is up 170%. It makes servers for data centers (and into those servers go many of Nvidia’s chips). The demand for more data center computing capacity is directly related to the increased demand for powerful semiconductors that in turn handle this AI demand. This buildout of AI capacity and the demand for cloud computing are secular growth drivers that will likely be in place for at least the next several quarters.

Elsewhere in the economy, however, we’re seeing signs that the underpinnings of consumer spending may be weakening. While aggregate real personal consumer spending growth has been hovering around 2.5% for the last few months, consumers at the lower end of the income distribution have been facing more challenges. They are the most impacted by the much higher prices that we’re seeing in food, housing, and transportation. The most recent quarterly reports from McDonald’s, Starbucks, and Target all show a consumer who is pulling back on discretionary spending.  Target announced in May that in order to attract consumers who have been hit hard by inflation, it would cut prices on 5,000 items such as “milk, meat, bread, soda, fresh fruit and vegetables, snacks, yogurt, peanut butter, coffee, diapers, paper towels, pet food and more.” Ulta Beauty, now in most Target locations, provides further insight on the health of the middle-market consumer. The company recently commented that it is seeing more cautious spending across various price points and segments. McDonald’s and Burger King are bringing back their value meal options, priced at only $5, in a bid to appeal to the cash-strapped consumer.

A telling sign of the tightened budget situation for consumers is seen in the delinquency rates on credit card loans. Notice that it has picked up significantly over the last several quarters and is now above pre-Covid levels.

Moreover, this chart does not include delinquencies on the newly available “buy-now-pay-later” (BNPL) loans. According to a recent report by the Consumer Finance Protection Board (CFPB), BNPL borrowers are more likely to be highly indebted, or carry a balance, or have delinquencies on their credit card accounts compared to non-BNPL users. Most BNPL users tend to be those with incomes under $75,000 and they also tend to be renters instead of homeowners. The CFPB announced in May that these loans will now be classified as credit card loans instead of as installment loans as they were prior. This will likely move the delinquency rates above higher in the months ahead.

While the S&P is up a healthy 10% YTD because of companies, such as Nvidia and Super Micro Computer, the weakness in consumer spending is showing up in the Consumer Discretionary sector’s performance within the S&P 500. Year to date, Consumer Discretionary is the second weakest sector, down 0.30%, while the worst performing sector is the highly interest-rate sensitive Real Estate sector, down 4.90%. On the other side, the two sectors leading the pack are Communication Services and Info Tech, up by 19.5% and 15.6%, respectively. Unsurprisingly, the mega cap names within those two sectors are driving their performance. The broader market sits between these extremes.  The S&P 500 Equal Weight Index is trading at 16.4 times forward earnings compared to the S&P 500’s 20.8x. And YTD the equal weight index, which captures the change in the average stock, is up 4.40%.  Despite all the excitement over AI, and the concerns over the consumer, the average stock’s performance YTD is fairly decent, but it tends to get missed in the comparison to the overall S&P 500’s return led by the strong AI names. Time will tell if all of this build-up over AI is overdone and over-hyped, for now it’s got the market’s attention. But, beneath the surface of the market we’re seeing middle-income and lower-income consumers that are showing signs of fatigue and appear to be pulling back on discretionary spending. Perhaps we are finally starting to see higher-for-longer interest rates finally having the impact desired by the Federal Reserve. We’ll see whether these reports of a spending slowdown become more prevalent and how this affects the rest of the market in the months ahead. In the meantime, we have included some defensive positions in our strategies.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.