When the going gets tough, the tough go shopping.
That sentiment has long underpinned U.S. fiscal might, as consumer spending has fueled growth for decades and remains the major driver of the nation’s gross domestic product.
No wonder then that the financial health of shoppers is in sharp focus now, amid the Federal Reserve‘s bid to tame inflation without tipping a mild slowdown into bumpier territory.
As is often the case, the difference between a soft economic landing and a hard one rests in large part with the wealthiest Americans and their purchasing decisions. The companies catering to their shifting shopping habits will best ride out the storm.
Let’s start with a bit of good news. “Consumers are going to have a little tougher time, but this is by no means a disaster,” says Doug Kelly, partner and portfolio manager Williams Jones Wealth Management. “The consumer, and especially the higher end consumer, is in pretty good shape.”
Still, not disastrous is a low bar, and while we’ve seen some marginal relief on inflation in recent months, the soaring costs of many essentials has a wide swath of consumers pulling back. The question is by how much; the answer varies by income.
In the U.S. the top 20% of U.S. households account for nearly 40% of all consumer spending, or 28% of gross domestic product. These Americans—whose mean income tops $176,000 a year after taxes, according to the Bureau of Labor Statistics—not surprisingly tend to weather economic downturns more easily; when they don’t, then it’s time to worry.
Indeed, government data stretching back to the mid-1980s shows that highest income households didn’t slow their annual spending as much as overall consumers did in the 1990s, and this cohort didn’t even flinch during the dot com bubble. The 2007-09 recession, when both the stock market and home prices declined, was the only period of prolonged year-over-year declines in average expenditures among this group.
In other words, the spending patterns of the top 20% can in some ways mean the difference between a short recession and a long one.
The problem is that while the BLS data date to 1985, inflation is running around highs not seen in four decades. And while those in the higher-income brackets are in many cases still spending and trading down to cheaper goods less frequently, they’re not entirely immune to inflationary pressures. According to recent survey work by
Willis Towers Watson
36% of Americans making six figures are living paycheck to paycheck; LendingClub says 30% of those earning $250,000 a year are as well.
In addition, they may be more inclined to cut back before it becomes absolutely necessary to do so.
“A lot of folks were able to amass the wealth they have by making good financial decisions, and it’s a good financial decision to tighten your belt” at times when the cost of living is rising drastically, says Jon Ekoniak, managing partner at Silicon Valley-based Bordeaux Wealth Advisors.
Still financial savvy cuts both ways, and through luck or good management, the top 20% of households are entering this uncertain economic period in good shape. This group, which owns roughly 74% of financial assets and 54% of nonfinancial assets (like houses) has nearly $60,000 in excess cash per household, more than four times as much as the next quintile down the economic ladder, according to data from the Federal Reserve and
Morgan Stanley
.
With tight supply meaning it’s unlikely we’ll see drastic home price declines—a big culprit behind the Great Financial Crisis’s spending decline—Ekoniak argues that any near term recession would look more like 2001 than 2008 for high-income Americans.
The strong labor market offers more hope. “There is a big difference between inflation being up 8% to 10%, and consumers thinking, ‘I’m spending more, I need to cut back a bit,’ and ‘I lost my job, now I need to cut back 30-50% or more.’ That’s when you get into a different ballgame,” says Ekoniak. “Our clients, as they continue to stay employed, they’re feeling relatively nervous but good.”
Shoppers visit a Tesla store at the King of Prussia Mall in the Philadelphia suburb.
Photograph by Jonno Rattman
The upshot is that right now, it appears those at the top of the income spectrum are poised to keep spending, likely limiting the severity of any economic downturn. Nonetheless that spending may look different than it has in recent years.
Take travel, a category skewed toward high earners. Americans have been making up for lost time with vacations, and in some cases don’t plan to slow down, no matter the cost. Compared with prepandemic levels, last-minute summer cruise bookings are up nearly 10%, says Christie Hudson, senior public relations manager for
Expedia
(EXPE) North America. “We expect to see this trend continue to grow as we move further into the summer and anticipate 2023 to be a record-breaking year.”
Mel Dohmen, senior manager of brand marketing for Hotels.com, which is owned by
Expedia
,
tells Barron’s that he is “already seeing indications of strong demand beyond the summer months.” That’s for both domestic hot spots like Orlando, as well as pricier international locations like Mexico’s Riviera Maya, Paris, London, and Rome.
Likewise
Marriott International
(ticker: MAR) President Stephanie Linnartz says the company’s higher-priced premium and luxury brands are seeing positive momentum, and international luxury demand is higher than in 2019 too. Average daily rates have been above prepandemic levels and luxury resorts were a standout in the U.S. over the Memorial Day weekend.
“Demand across customer segments in many markets around the world continues to be strong,” Linnartz says, noting that while the company is watching the macro backdrop carefully, Marriott is “still optimistic about the outlook through the end of this year and expect to see meaningful additional global recovery.” That’s bolstered by several factors, including people’s “desire to spend money on experiences versus goods.”
That preference has been on display in retailer earnings revisions in recent months, with companies across the spectrum warning that Americans are buying fewer things than they did during the pandemic.
While shares of companies like Marriott continue to look intriguing—given a string of strong earnings, upward profit revisions on the Street, and return on equity that appears stubbornly higher than 2019 and before—retailers have already seen their Covid boosts fade.
Nordstrom
’s
(JWN) most recent quarter speaks to how consumer constraints are reaching ever higher up the income spectrum–to a point. The company’s first quarter results were so strong it markedly lifted its full-year forecast, but just one quarter later it reversed course. Its off-price
Nordstrom
Rack division saw sales growth fall to less than half the level of its full-price flagship brand, with the latter buoyed by double-digit designer sales.
Makeup sales have remained strong. Above, Ulta Beauty’s perfume section in King of Prussia.
Photograph by Jonno Rattman
Macy’s
(M) said demand for higher-end products was still high even as it cut its full-year guidance on macro headwinds.
Macy’s
same-store sales declined last quarter at its departments stores but rose at its Bloomingdale’s and BlueMercury divisions, which attract high-end shoppers. Lackluster results from luxury consignment firm
RealReal
(REAL) show that aspirational high-end sellers are starting to feel a bit of a pinch even as those buying luxury goods are still going on shopping sprees.
These results suggest that some upper middle class Americans are being more cautious, even as those at the very top keep spending freely. That group could help some luxury goods sellers buck the trend.
Estee Lauder
(EL) is a longtime Barron’s favorite. The shares are up by nearly a third since we recommended them in summer of 2020, ahead of the broader market’s rise, and still look attractive on multiple fronts, as makeup sales recover, international markets reopen, and shares are cheap.
William Jones’ Kelly, who has eschewed consumer exposure, nonetheless owns
Estee Lauder
,
a name that caters to wealthier clientele but offers relatively inexpensive indulgences. “In a recession, a tube of lipstick is a nice luxury that doesn’t cost you a ton.”
He also likes that Estee Lauder gets more than a third of its business from China, which is still in early days—in terms of emerging from pandemic lockdowns and in adopting premium skin care and cosmetics.
China remains a key wildcard for other luxury brands as well, but one that could quickly turn into a tailwind if travel restrictions ease at a time when property values hold up and postpandemic spending patterns look poised to resume.
The same day that the market was digesting
Walmart
’s
lowered full-year outlook,
LVMH Moët Hennessy Louis Vuitton
(MC.France) delivered a robust second quarter, marked by stronger-than-expected double-digit sales increases and expanding margins, bolstered by price increases.
Yet their business has yet to see the big boost in China that some peers, like
Hermès International
(RMS.France), have notched, and that uncertainty has partly led to a forward multiple below its historical averages even as earnings estimates on the Street are climbing. Still, strength in the U.S. and Europe is more than compensating from its depressed Asia business, and LVMH has one of the highest returns on equity of its peers.
In addition, LVMH looks more insulated from the execution pitfalls and potentially more promotional atmosphere among digital-first luxury brands like
Farfetch
(FTCH) and even reseller
RealReal
,
which remain unprofitable.
Groceries and fashion? A Louis Vuitton bag in a Costco customer’s cart in King of Prussia.
Photograph by Jonno Rattman
Recent robust earnings from
Ferrari
(RACE) are another indication that the ultrarich’s appetites haven’t slowed. The shares change hands for 36 times forward earnings, just below their historical average, even as analyst earnings estimates have been rising, helped by planned price increases on the heels of record sales.
Unlike average upper middle class consumers, whose discretionary income could run into five figures,
Ferrari
’s
customers are in an echelon apart, one that, for the most part, sailed quietly through the 2007-09 recession and could be even less bothered by a milder downturn.
Ultimately, economic risks are rising for the second half of 2022, and factors beyond consumers’ control, from interest rates to housing starts, will play a role in their ability to keep spending at a time when inflation remains at historic highs. That’s created a perfect storm among retail stocks, which have been understandably battered.
However data from the labor and housing markets so far indicate we aren’t closing in on doomsday. A less dramatic downturn should allow financially secure consumers to bounce back more quickly, while the wealthiest keep spending apace. After all, Americans’ love of shopping has endured through thick and thin, through pandemic and health.
Masks may now be optional, but wallets will likely stay open.
Write to Teresa Rivas at teresa.rivas@barrons.com