Article written by Scott Haslem. Published in The Australian Financial Review April 15, 2024.
There has been a sharp slowing in consumer spending over the past year. But after some further near-term weakness, things may start to turn around from mid-year.
This is because of the stage three tax cuts, the likely additional cost-of-living relief in May’s federal budget and a further solid minimum wage gain.
Modest RBA rate cuts from mid-year may also provide support. With virtually everyone now on flexible mortgage rates, this could be powerful.
For investors looking to retail stocks, consumer demand may become less value-orientated and more growth-orientated, reversing the trend of the past year.
This would be reflected in consumers reverting to branded labels at supermarkets, and drifting back to mid-price versus low-price retailers for homewares and clothing.
Demand for growth-oriented larger ticket discretionary purchases such as cars could also start to improve, including spending on items linked to currently depressed new home building sector.
Over the past year, the economy has been growing well below average and unemployment has started to drift higher.
A key reason has been a sharp slowing in consumer spending. We can see this in the comprehensive quarterly GDP data, which includes goods and services (including all the necessities like electricity, interest and healthcare).
After surging by 6.6 per cent in 2022 driven by the post-pandemic rebound, consumer spending (adjusted for inflation) has slumped to just 1.1 per cent in 2023, as the impact of 2022’s rapid rate hikes (and higher prices) weighed.
By the end last year, spending growth was essentially zero. Given 2.5 per cent population growth, this means we’ve been tightening our belts, which is precisely what the RBA wants us to do to take some of the heat out of inflation. Indeed, the consumer is now at its weakest since the GFC (2008), excluding the pandemic.
The downside to the GDP data is that it lags. Getting a pulse on the consumer requires looking at the partial (and goods-heavy) retail sales data.
And that’s been volatile, not least due to changing spending patterns around events like November’s Black Friday sales, as well as Taylor Swift ticket sales, which boosted demand during February.
Recent data suggests consumer demand is flat-lining, but not collapsing, in early 2024. The resilience of wealth – for those who have it – has probably helped steady the ship, given the recent acceleration in house prices and equities.
While interest rate conditions are “restrictive”, when the gain from wealth over recent quarters is included, overall financial conditions are arguably average, according to analysis by investment bank UBS.
This suggests a growing divide between the haves and the have-nots that may impact retail trends.
Retail spending – particularly on discretionary items – provides an interesting soliloquy of how the consumer has evolved over the recent past, and how investors have played that.
From mid-2022, a weaker consumer outlook saw investors target sectors with resilient earnings streams.
These included travel, entertainment and gambling, supported by wealthier consumers and those with pent-up demand post the pandemic. These sectors have performed strongly over the past year.
As consumer demand slowed through 2023, the baton was passed to sectors that would likely do well as consumers tightened their belts. These “value-orientated” parts of the retail sector included department stores selling cheaper household supplies, homewares and clothing.
Over the more recent past, companies more synonymous with discretionary retail have performed well. But again, it’s been the smaller-value end of electronics, furniture and auto spare parts, rather than big-ticket durables or cars.
Throughout the consumer slowdown, staples (like supermarkets) have seen demand shift more value-orientated, initially moving from branded goods to more expensive private labels.
Eventually, the generic own-branded items have seen strong demand as income has been squeezed.
Can the consumer look across the valley to better times, and lift spending now? More likely, spending will slow further into mid-year.
According to Barrenjoey, another investment bank, the jobs market is now on a clear weakening trend, suggesting the consumer may turn negative in the months ahead.
Any pressure on retail margins should also help manage inflation lower.
Eventually, when that income relief arrives, consumer spending may start to stabilise and recover.
Thawing trade relations with China may also benefit some sectors in the year ahead.
The question for investors is whether to position into some of those retail stocks now or wait for further weakness to appear in the months ahead.
Retail shares could under-perform the broader market due to consumer weakness. Combined with a more proximate uplift in household income, this could flag a potential future opportunity to buy into.
