Consumers Still Spend, But What They Buy is Changing

U.S. households aren’t exactly running out of money, but they’re directing their dollars elsewhere. Companies’ inventories are broadly growing, diminishing the forward-looking threat of supply chain disruptions, but are being met with lower demand from reopening-minded consumers. Some inflation pressures are showing signs of cooling off, but the price increases we’ve already seen, plus continued pressure from soaring food and energy costs might be starting to show up in earnings.

It doesn’t seem like overall consumer spending power is falling apart. For lower-income consumers, higher food and energy costs are likely to erode discretionary spending. For wealthier households, the shift from spending on stay-at-home comforts toward experience-oriented travel, leisure and entertainment activities is underfoot.

A thread throughout the investment (and inflation) narrative of the past year has been that “demand is booming while companies don’t have enough inventory, and supply chain stress is preventing them from restocking.” Now that demand is slowing, the tide is turning: Inventories jumped sharply higher in Q1 for companies. This inventory accumulation likely means that looking forward, big retailers will probably start ordering less from their suppliers. Wholesale demand looks set to decline from here, and the difference between wholesale inventories and sales is already back to pre-pandemic levels.

Slowing demand and rising inventories will result in weaker margins, and therefore weaker bottom-line earnings. Extrapolating this to the broad market, note that up to this point the stock market selloff has been attributable to a meaningful decline in valuations. The S&P 500 is trading at 16.5x the expected earnings over the next 12 months — below the average valuation of the past 10 years. Sustained valuation unwinds tend to precede downward earnings revisions.

It seems inevitable that wage-cost pressures on margins will prompt many employers to slow, or even potentially freeze, their hiring plans. With nearly two open jobs for every unemployed person in America right now, that’s not necessarily a bad thing … especially if it helps coax broader inflation induced by risings wages to slow down.

Said plainly, these earnings learnings highlight broader economic and market risks. They also underwrite many of the investment calls to action we’ve been making. Core bonds are our highest-conviction idea. Stick with stocks, but bias new money toward quality segments or exposure with downside protection. Consider allocations that can perform well if risks win out.

Rick Barragan is the Managing Director, Los Angeles Market Manager, for J.P. Morgan Private Bank.
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