Rising Consumer Stress Prompts Caution Among Fund Managers

Despite Broader Stock Market Rally, Signs of Consumer Stress Lead to More Conservative Outlooks

As the broader stock market continues to rally, some fund managers are growing more conservative in their outlook due to signs of rising consumer stress. While unemployment remains near historic lows, the Federal Reserve's efforts to combat inflation through interest rate hikes are starting to weigh on households.

Consumer confidence experienced a larger-than-expected decline in August, and delinquency rates on credit cards issued by smaller banks are at record highs, according to data from the Apollo Group. Major department stores like Nordstrom and Macy's have reported rising delinquencies on their store cards.

Additionally, the resumption of payments on approximately $1.1 trillion of federal student loans in October could result in a "payment shock" of $500 or more each month for consumers, according to a study by TransUnion.

Emily Roland, co-chief investment strategist at John Hancock Investment Management, expressed concern about the state of the U.S. consumer, stating that they are "on thin ice coming into the final stretch of 2023." She is more bullish on bonds and defensive sectors like healthcare as the fourth-quarter holiday shopping season approaches.

While the U.S. economy added 187,000 non-farm jobs in August, slightly exceeding expectations, the unemployment rate also rose to 3.8%, with revised estimates for job growth in June and July being significantly lower than previously reported.

Further declines in the labor market could have a dual impact on investors by alleviating some inflation pressures while simultaneously weighing on consumer spending. Although overall consumer spending exceeded expectations in August, the savings rate fell to its lowest level since November 2022.

Jake Jolly, senior investment strategist at BNY Mellon Investment Management, is underweight on equities and believes the U.S. economy is headed toward a recession. He questioned how long consumer spending can continue to surprise on the upside.

Gregory Daco, chief economist at Ernst & Young, predicts that consumer spending growth will decline from 2.3% in 2023 to 0.9% in 2024 due to higher interest charges, reduced available savings, and student loan payments. He anticipates below-trend economic growth for several quarters.

Investors will be closely watching upcoming data on consumer credit usage and the ISM services sector, which accounts for two-thirds of the economy. While betting against consumer spending has so far been an unsuccessful wager, there are expectations that interest rates will fall in the fourth quarter and into 2024 as inflation concerns ease.

Jason Draho, head of asset allocation Americas at UBS Global Wealth Management, believes that despite the challenges, the U.S. consumer and economy should remain resilient well into 2024. He expects investors to buy into consumer stocks during market dips.

The consumer discretionary sector, including companies like Amazon.com, Royal Caribbean Cruises, and Chipotle Mexican Grill, has posted significant gains this year, nearly double the S&P 500 index's performance. However, the sector has recently lagged behind the broader market.

Sandy Villere, a portfolio manager at Villere & Co., anticipates that even if consumer spending falls significantly, the strong rally in the consumer discretionary sector will likely wane as the broader market slows in the fourth quarter. As a result, Villere is increasing positions in defensive sectors such as healthcare.

"We think it's premature to move away from the consumer now, but we can see a recession hitting in the first quarter as the Fed's rate hikes start to kick in," Villere said.