The Big Idea

Consumers alive and well

Stephen Stanley | April 28, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Real consumer spending grew an annualized 3.7% in the first quarter this year, the best performance since the spring of 2021 when the economy was still recovering from the initial pandemic lockdowns. This defied many economists’ assumption that households were tapped out. But beyond government data on spending, there is also a lot to learn about the state of the consumer from the quarterly earnings of bellwether consumer-facing corporations.  Two themes stand out from the companies reporting so far: demand remains firm and households continue to accept rising prices.

Strong demand

Consumer spending clearly jumped in the first quarter even though some of the apparent strength may have reflected seasonal adjustment difficulties. Nonetheless, while the consensus continues to call for recession within a few months, consumer spending accelerated last quarter even as the savings rate rose. And households continue to sit on an unusually large cache of liquid assets.

A number of firms reported benefiting from households’ strong financial positions in the first quarter.  Procter & Gamble and Kimberly-Clark, which sell a variety of staples like diapers, detergent, toothpaste, and paper products, both reported better than expected results.  The CEO of P&G noted that “the U.S. consumer is holding up well.”

Spending on food performed well too.  Coca-Cola and Pepsi both exceeded expectations for both revenues and volumes.

Restaurant chains also had good things to say about the consumer.  McDonalds posted a year-over-year same-store sales gain of over 12%.  Chipotle exceeded sales expectations too.

Consumers have shifted focus somewhat away from goods and back toward services, reversing the trends forced on households during the pandemic.  In particular, one soft spot for spending in recent months has been big-ticket goods, especially those associated with homes, in line with the soft housing market.  Whirlpool reported a 5% drop in sales year-over-year, reflecting a drop in demand for appliances.

However, auto companies are benefiting, as persistent shortages during the pandemic have left households with pent-up demand for vehicles.  GM officials noted that consumer interest remains strong, even for high-end expensive models.  Spoiler alert: unit vehicle sales likely increased in April.

The major airlines are all reporting that demand for flying remains robust despite high airfares. American, United and Delta have all indicated this month that their forward bookings are strong, especially for international travel.  Meanwhile, Hilton reported better-than-expected first quarter earnings this week, underscoring the momentum in the travel sector.

To be fair, many of the executives reporting strong backward-looking figures expressed caution about the outlook.  There seems to be a widely held view amongst corporate executives, likely reflecting the consensus that they are hearing from economists and others, that a recession is likely just around the corner.  Of course, CEOs were saying similar things three months ago and likely three months before that.

Pricing power

In many cases, the latest upside earnings surprises reflected the fact that sales volumes held up or even continued to rise even in the face of sharp price hikes.  It is striking how many of these large corporations noted that consumers are continuing to accept inflation, a dramatic departure from the norm over the past 20 years.

Procter & Gamble and Kimberly-Clark both reported double-digit price hikes over the past year.  P&G’s CEO noted that in Europe, consumers are trading down to cheaper private-label brands, but they are not seeing that as much in the US.

Coca-Cola and Pepsi are both starting to see evidence that consumers may be changing their habits a little in response to inflation. But Pepsi boosted its revenue growth projection for the year by two percentage points, even as its price/mix, which factors in pricing as well as packaging and size (shrinkflation), was up a stunning 16% over the past year.  Nestle hiked prices over the past year by close to 10%.

In the restaurant space, McDonald’s is starting to see more resistance to higher prices, but Chipotle reported that it continues to have considerable pricing power.

GM’s CFO noted something that I have noticed: “Everybody sees (price) declines around the corner. That corner just keeps getting further and further out.”

While price momentum in the goods sector may indeed be waning, the services sector, where the Fed is currently focused most intently, continues to report ample pricing power. Airlines, for example, are enjoying robust demand at a time when capacity is limited, which gives them plenty of leverage to keep increasing fares. Hotels are also happy to limit their available rooms amid a labor shortage and thus continue to have strong pricing power.  Hilton noted that its average daily rates increased by 11%.

Many of the executives reporting these results wondered at the strength in revenues in the face of such sharp price increases.  With inflation being Public Enemy #1 and some politicians decrying corporate greed as the root of inflation, CEOs are wise to offer circumspect pricing outlooks.  However, as long as consumers are willing to pay more, prices are likely to continue to rise.  And as long as households are flush and unemployment is historically low, they are probably not going to respond to higher prices with a buyers’ strike.

Conclusion

The corporate earnings reports for the first quarter that have been released over the past two weeks suggest that the consumer is not only continuing to spend but is also still not phased by hefty inflation. While there is a broad consensus that the consumer is just about to roll over, I would concur with GM’s CFO that the timetable for such an event is likely to continue to get pushed back so long as the underlying financial situation for most households remains favorable.

For Fed officials, the most troublesome aspect of the recent news is that the momentum behind inflation does not appear to be cooling nearly fast enough, especially in services industries.  A slow winddown of inflation is the main reason that I expect the Fed to be on hold well into 2024 before it can finally begin to ease, far later than the markets are currently pricing.