Consumer Strength. B a c k b o n e Of A C on tin u in g E con om ic E xpan s ion. Mark Luschini Chief Investment Strategist
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1 Consumer Strength B a c k b o n e Of A C on tin u in g E con om ic E xpan s ion Mark Luschini Chief Investment Strategist INVESTMENT Michael J. Halloran, CFA Strategy Analyst STRATEGY GROUP
2 We are now six years into the current economic expansion and a rising stock market. A question we are frequently asked is: What can keep the economy and stock market going and how will this be accomplished? We think the consumer is the key to future economic growth and positive stock market performance. This piece examines the health of the consumer and concludes that a healthy consumer can underpin further economic growth and stock market gains. Importance of Consumer to Economic Growth The U.S. consumer is the most important part of the economy with consumer spending making up about 68% of the U.S. economy. This figure dwarfs the remainder of the economy consisting of investment, government purchases, and net exports (exports minus imports). Consumer spending includes purchases of everything from cars, homes, and insurance to groceries and health care. This spending is vital to economic growth with the things we buy creating the demand that helps companies grow profits and hire new workers. Companies with growing profits ultimately support higher stock prices. Figure 1: Relationship Between Stock Price Performance and Economic Growth Anatomy of The U.S. Consumers Return To Health Lower Debt Levels: Consumer borrowing plays a major role in economic growth. This borrowing supports the purchase of homes, autos, education, and more. But too much borrowing can be a bad thing. Leading up to the financial crisis, consumers supplemented their spending by borrowing more than they could afford. This was unsustainable and played a major role in the crisis. Since the crisis, consumers have made significant progress on reducing their debt levels and are well positioned to support economic growth. Figure 2: Significant Progress has been Made Toward Sustainable Consumer Debt Levels. Rising Stock Prices Depend on Consumer-Led Economic Growth Consumer Debt Levels S&P 5 Stock Index Level /1/24 Weak Consumer led to Recession and Falling Stock Prices. 6/1/25 12/1/25 6/1/26 12/1/26 6/1/27 12/1/27 6/1/28 12/1/28 6/1/29 12/1/29 6/1/21 Rising Stock Market caused by Consistent Economic Growth and Improving Consumer. 12/1/21 6/1/211 12/1/211 6/1/212 12/1/212 6/1/213 12/1/213 6/1/214 12/1/ GDP Growth Rising consumer debt provided a tailwind to the 8s and 9s economic boom. Consumer debt climbed to unsustainable levels before crisis. Consumer debt is now at a lower, sustainable level. S&P 5 Index (LS) GDP Growth (RS) (Source: BCA Research 214, Congressional Budget Office [CBO]) Figure 2 shows consumer debt rising to unsustainably high levels leading up to the financial crisis and also shows the significant progress that has been made toward reducing debt to sustainable levels. This debt reduction process (known as deleveraging) resulted in sluggish economic growth as consumers paid down debt instead of making purchases. The good news is that this process of 2
3 debt reduction is largely over, with consumer purchasing power now in a much healthier position. Supportive Federal Reserve: The Federal Reserve also played a significant role in helping the de-leveraging process with extremely low interest rates since the crisis. Figure 3 shows that the household debt service ratio (total required household debt payments to total disposable income) is now at historically low levels. This is thanks to lower absolute debt levels and record low interest rates. This historically low level of debt service puts the consumer in a good position to make major future purchases like homes and autos. Figure 3: Household Debt Service Levels are Now at Historical Lows and Well Positioned to Support Consumption. Figure 4 shows unemployment has fallen from a peak of 1% to a much healthier current reading of 5.4%. We have created over 12 million jobs since the crisis and are beginning to see wage growth accelerate. A solid labor market is a key pillar supporting consumer confidence and spending. Figure 4: The Labor Market Has Been Making Steady Improvement since the Crisis. U.S. Unemployment Rate A much healthier labor market is key to future consumer spending. U.S. Household Debt Service Ratio % Rate 6 % of Disposable Income Debt service rose to unsustainable levels before the crisis. Historically low levels of debt service can now support healthy consumption growth. Healthy Labor Market: Improvement in the labor market has also helped the consumer. 4 2 Labor markets have returned to health. Pent-Up Demand: While the consumer was paying down debt, they were delaying purchases of many goods and services. This created pent-up demand that should continue playing a major role in supporting economic growth in the coming years. Housing is probably the best example of pent-up demand and is shown in Figure 5. We expect housing activity to gain momentum throughout 215 and beyond due to better job security and wage gains, low mortgage rates, and an improving household formation rate that has been very depressed. 3
4 Figure 5: Housing Continues to Heal from the Financial Crisis Collapse with Lots of Pent-up Demand. Figure 6: Record High Household Net Worth Supports Confidence and Consumer Buying Power. U.S. New Homes Sold (Annual) U.S. Household Net Worth (Nominal USD) 1,6 1,4 9, 8, 1,2 7, Thousands of homes 1, 8 6 Significant pent-up housing demand is slowly being released. Million USD 6, 5, 4, 3, Record high consumer net worth , 1, Record High Consumer Net Worth: While economic growth has been weaker than most everyone would like, it is resulting in higher home and stock prices that has propelled household net worth to record levels as shown in Figure 6. Improving Confidence and Consumption: All of this is resulting in improving consumer and business confidence that should support consumer spending and business investment in the coming years. Figure 7 shows Consumer Confidence grinding higher from the lows of the financial crisis to much healthier levels today. A healthy, confident consumer with solid job prospects is resulting in a recovery to trend levels of consumer spending as shown in Figure 8. We think this pace of consumer spending is sustainable in the coming years and should ultimately result in increasing corporate profitability that will support higher stock prices. Figure 7: A Six-year Economic Expansion with Solid Labor Markets, Record High Net Worth with Lower Debt is Causing Consumer Confidence to Rise. Conference Board Consumer Confidence Index Consumer confidence continues to grind higher. 4
5 Figure 8: A Healthy Consumer Leads to Rising Consumption That Underpins Economic Growth and Higher Stock Prices. U.S. Personal Consumption YOY Change Healthy consumer is leading to steady consumption. Financials: Financials are benefitting as consumer credit quality continues to improve and non-performing loans continue to fall. With an improving economy and stronger balance sheets, banks are well positioned to lend. Meanwhile, consumer demand for home and auto loans continues to improve. More readily available credit (and demand for it) has typically been a leading indicator of financial sector profit acceleration. Banks, insurers, and credit card companies are all benefitting from increased activity while valuation remains supportive. Health Care: Health care spending is outpacing consumer spending which typically leads to health care earnings outperformance and improving valuations. The pace of health care expenditure growth should continue to exceed that of the overall economy with pent-up demand for health care services, lower unemployment levels, rising commercial insurance membership, and aging demographics bolstering the sector. Table 1 shows the actionable investment ideas that should benefit from this healthier consumer. Actionable Investment Ideas: There are several sectors of the economy with stocks that should benefit disproportionately from sturdier consumer balance sheets. Consumer Discretionary: This sector is an obvious winner and recent data suggests that consumers are allocating a larger share of their incomes to discretionary spending. In addition to housing mentioned above, other industries are benefitting. Restaurants are particularly well positioned with sales growing at their fastest pace in more than a decade. Fundamentals for lodging are also bullish with consumers spending more on leisure and travel. 5
6 Table 1: Actionable Investment Ideas Driven by Consumer Strength. Company Name Consumer Discretionary Ticker Forward P/E Earnings Growth Dividend Yield Credit Rating Notes Coverage The Consumer Discretionary sector is the major beneficiary of a strong consumer with lots of industries showing strong fundamentals including home builders, hotels, restaurants, and media. CHIPOTLE MEXICAN GRILL INC CMG MCDONALD S CORP MCD A- Gaining share with superior combination of growth and store level returns. Largest fast food restaurant in the world with significant dividend. WALT DISNEY CO/THE DIS A Iconic consumer brands with a strong management team. S&P/J COSTCO WHOLESALE CORP COST A+ MARRIOTT INTERNATIONAL -CL A MAR BBB APPLE INC AAPL AA+ AMAZON.COM, INC AMZN AA- CONSUMER DISCRETIONARY SELECT ETF ISHARES U.S. HOME CONSTRUCTION ETF Financials XLY Consistent earnings track record with strong cash flow and balance sheet. Benefitting from strong fundamentals and returning capital to shareholders. Apple platform has over 9% customer retention while returning shareholder cash. E-commerce continues to take share and AMZN is the dominant force. Offers diversified exposure to 87 Consumer Discretionary stocks. ITB Offers diversified exposure to 38 home construction stocks. The Financial sector has healed from the financial crisis and is well positioned to extend the needed credit and insurance for pent-up consumer expenditures. ALLSTATE CORP ALL A- DISCOVER FINANCIAL SERVICES DFS BBB- JPMORGAN CHASE & CO JPM A WELLS FARGO & CO WFC A+ Solid returns, valuation support and is returning cash to shareholders. Industry leading revenue growth, solid credit quality and buying back shares. Top management and deep bench with risk reduction as a catalyst. Solid management and well positioned for consumer credit needs. SIMON PROPERTY GROUP INC SPG A Real estate that is well positioned for a healthy consumer. FINANCIAL SELECT SECTOR SPDR ETF XLF Includes 88 stocks for broad-based financial sector exposure. SPDR S&P REGIONAL BANKING ETF KRE Includes 9 equally-weighted regional bank stocks. ISHARES U.S. INSURANCE ETF IAK Includes 64 U.S. insurance provider stocks. Health Care The Health Care Sector is a major beneficiary of job growth, increased insurance coverage (Obamacare), an aging population, and future high levels of healthcare spending. MEDTRONIC PLC MDT A Very diverse product line, strong cash flow, valuation and dividend support. BRISTOL-MYERS SQUIBB CO BMY A+ Multiple catalysts driving Immuno-Oncology franchise. MCKESSON CORP MCK BBB+ GILEAD SCIENCES INC GILD A- HCA HOLDINGS INC HCA Drug distribution benefitting from strong pricing with cross-sell opportunities. HCV market still in early stage while stock is trading well below historical levels. Hospital fundamentals are solid with HCA levered to many growth categories. VANGUARD HEALTH CARE ETF VHT Cap-weighted basket of 318 companies offers broad exposure. ISHARES U.S. MEDICAL DEVICES ETF IHI Cap-weighted basket of 49 manufacturers and distributors. ISHARES U.S. HEALTHCARE PROVIDERS ETF IHF Cap-weighted basket of 5 health care providers. ISHARES US PHARMACEUTICALS ETF IHE Cap-weighted basket of 41 pharmaceutical companies. /J /J /J S&P/J S&P/J /J S&P S&P Definitions: Forward P/E - Current stock price divided by EPS consensus estimate for the next four quarters. Earnings Growth Estimate - Mean broker estimate of the compounded annual growth rate of the operating eps over the company s next full business cycle (typically 3-5 years). Dividend Yield - Trailing 12 month dividend per share divided by share price Credit Rating - Rating assigned by Standard & Poor s to the long term obligations of the issuer if repaid in the local currency of the issuer. 6
7 Disclosure This is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinions expressed within. Indexes are hypothetical portfolios of specified securities, the performance of which is used as a benchmark in judging the relative performance of securities. Indexes are unmanaged portfolios and do not guarantee future performance. Index performance returns reflect results of an asset class based on target allocation weightings. Weightings are subject to change. Index returns are for illustrative purposes only and do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and it is not possible to invest directly in an index. A client s investment results are reduced by advisory fees and transaction costs and other expenses including advisory fees charged by mutual funds that may be held in the account. All calculations were based on information obtained from sources we believe to be reliable, but we cannot guarantee the accuracy of such information. Janney makes no representation that an account will obtain gains or losses similar to those illustrated. There are distinct differences between hypothetical performance and performance achieved by actual trading platforms. Hypothetical results in practice are prepared with the benefit of hindsight. Additionally, hypothetical trading does not involve the risks and cannot account for the impact of risk in actual trading. The ability to withstand losses or adhere to a trading program in spite of losses are material facts that can adversely affect trading results. There are other factors related to markets in general that cannot be accounted for in the preparation of hypothetical performance results. Performance data quoted represents past performance and is no guarantee of future results. Current returns may be either higher or lower than those shown. Individual account performance may not match the results shown and will depend upon various factors including market conditions at the time of investment. Janney investment professionals are available to discuss the suitability and risks involved with various financial products and strategies. We will be happy to provide a prospectus, when available, and other information upon request. 7
8 JANNEY MONTGOMERY SCOTT LLC The Highest Standard of Success in Financial Relationships Janney Montgomery Scott LLC Member: NYSE, FINRA, SIPC Ref. 1564
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