As excess savings have dried up, inflation has weighed on household budgets and the labor market has softened, high-income earners may cease to be the stalwarts of consumption.
The U.S. should be able to avoid recession this year, but economic growth hinges on one key participant: the consumer. Consumption underpins the economy, accounting for 68% of GDP.
After the pandemic, consumers enjoyed over $2.3 trillion in excess savings, powering spending in goods and services across income cohorts. However, in recent years, higher income consumers have been driving spending. The Federal Reserve1 measured retail spending patterns since 2018 and revealed that high-income earners began to outpace low- and middle-income consumers by fall 2021, a dynamic that has persisted to today. This has supported GDP growth.
However, as excess savings have dried up, inflation has weighed on household budgets and the labor market has softened, high-income earners may cease to be the stalwarts of consumption. That doesn’t mean spending will grind to a halt; instead, consumers may become craftier in their shopping habits. One trend that has emerged: simple luxuries.
A few bright spots within consumer and retail sectors have been resilient and could present portfolio opportunities:
- Staying home, but dining out: Within services, airline and hotel demand has weakened, but consumers are still enjoying meals out. Chase credit card data2 shows airline spending down 9.9% MTD vs. 2024 and lodging down 4.3% MTD. Each month this year has contracted with an accelerating downtrend for both categories. On the other hand, restaurant spending has grown every month since February 2024 and is up 2.2% YTD in retail sales. Select restaurant brands that can benefit from scale, are domestic and therefore more insulated from tariffs, or offer value menus/options may be best positioned.
- Brands, at a bargain: Luxury retailers may be seeing mixed demand, while discount retailers face challenges from a cash-strapped lower-income consumer. However, the sweet spot may lie in the middle. Companies offering branded apparel and accessories at a discount or selling stranded inventory may not only sustain demand, but also may have some remaining pricing power. Despite higher tariffs, retail sales in apparel have risen 1.3% YTD and 2.7% YTD in consumer spending.
- Upmarket staples: Consumer staples have been defensive but expensive, and face risks to already thin margins. Areas like packaged goods are confronted with competition from dining out and limited pricing power after the inflation surge. Although staples are considered to have relatively inelastic demand, lower income consumers often do curtail spending on essentials when budget constrained. However, national brands in household and personal care items, which appeal to middle- and upper-income consumers over generic brands, could be resilient. In addition, energy drinks or caffeinated beverages tend to have more durable demand.
Despite softer retail sales and consumer spending, discretionary spending growth has outpaced non-discretionary spending this quarter2, indicating that consumers are still enjoying small indulgences. However, there has been significant dispersion between competing companies in the consumer and retail sectors, requiring an active approach to stock selection.