Key Summary:

• Sentiment towards the consumer and spending is about as negative as I’ve seen.

• Assets and allocations to consumer-related stocks haven’t been this low ever.

• Are consumers tapped out or just fed up with high prices and sending brands a message?

Very Important thesis: If equities generate roughly 8-10% a year over time, leading brands serving the dominant driver of the economy, in theory, should compound at 10-15%+ over time. We have significant proof on this topic. In a world where rates and inflation are higher than we might like, business models with pricing power, exposure to quality factors, and that generate strong profits and free cash are set up to win versus the typical peer. Brands Matter.

Forecasts for Consumer Spending are Wide Enough to Drive a Truck Through.

I hope you are having a great summer! I was driving back from Lake Tahoe and listening to a popular financial media channel that was interviewing two “experts” on the health of the consumer and consumer spending trends. Both guests were clearly smart, well prepared, highly educated, and with multi-decades of experience. With all the same training and data, somehow these guests’ view about the consumer were diametrically opposed to each other. I think this interview sums up how the world feels about the consumer and therefore consumer stocks. Confused. So, let’s dig-in and try and make some sense of what’s happening in consumer-land.

I have been saying all year, the consumer will likely not be spending broadly and will be stingy about where and what she spends on. That will influence consumer stocks, and we should expect bifurcated performance in the sector. FYI, YTD, the Consumer Discretionary sector is the worst performing sector this year, which is very rare. When a sector tends to outperform often, the best opportunities often appear in the year when performance is sub-par. Not surprisingly, we are about as bullish as we have ever been on this sector as earnings revisions get to trough levels and much easier comparisons become the norm for the next 12 months.

Case in point: Nike is off 57% from its November 2021 highs. Lululemon is off 53% from its December 2023 highs. Disney is off 57% from its highs. Dollar General is off 54% from the highs seen in late 2022. The pandemic, the supply chain disruptions, 50-year high inflation, rapidly rising interest rates and the negative consumer sentiment affect have all conspired to create a difficult environment for the average consumer stock. But that is the past my friends.

Very Few Investors Have Any Real Exposure to Consumer Stocks.

Whether we like it or not, money flows follow recent performance, so the consumer sectors have been all but abandoned by investors and momentum traders. There’s a ton of diamonds in the dumpster today folks. In my last note, I talked about the most crowded trades and the likelihood they could introduce a lot of angst into investors lives as they unwound. With the help of the Yen carry-trade unwind as the catalyst, many of the most crowded trades became much more volatile than people thought possible. The knee-jerk reaction was to sell everything, but we know that’s always the wrong response. Since last Monday, markets have stabilized, and some fear has crept back into a complacent market. Overall, that’s a very good thing as investors and traders lean back on their heels again.

To highlight how little exposure the world has to consumer stocks today, I have added the excerpt from my last note showing asset levels across sectors. “Looking at the sector ETF’s with >$1B of assets, there’s roughly, $247B in total Technology assets versus about $27B in Consumer Discretionary assets and about $24B in Consumer Staples assets. So tech now accounts for over 9x more assets than Consumer Discretionary yet household consumption accounts for 70% of GDP…When I say, “the consumer sectors are under-owned and unloved”, I mean it’s at extremes I have NEVER seen.”

The Punchline: Consumers are NOT Tapped Out, They are Opting-Out.

I have not heard one consumer expert talk about the possibility that consumers are simply sending a message to companies that the prices are too high and they will return when they normalize. Not being willing to spend on an item is much different than not having the capability to spend. Yes, the lowest income cohorts, who always live paycheck to paycheck, have really had a hard time with 2 years of high inflation and higher rates. But the other 2/3 of the economy are employed, have stable to rising incomes, and have spending capacity. Do you think the consumer economy is really hurting when higher priced fast casual brands like Chipotle and Shake Shack are reporting solid results and traffic numbers? Or when the demand for Live Events like concerts remains robust? Or when consumers are willing to pay $28 for the $15 burrito to have it delivered by Uber Eats or Door Dash? Or when they choose to take the frequent, and expensive Uber rides? Consumers are spending situationally and with intent. That’s very different than being in turmoil.

There is very little evidence that broadly, consumers are in trouble. The data we have across every important consumer spending category continues to scream: the consumer is making choices because they are fed-up with higher prices and have started pushing back, and voting NO on items that are egregiously over-priced. This means there is a wall of consumer spending just waiting for prices to normalize, which we have already started to see in certain categories like grocery, warehouse shopping, chain restaurants, airlines, etc. Some industries and companies are more challenged with the ability to cut prices than others. This will continue to affect our stock selection and how much broad exposure we add over the next 6 months. In many cases, margins could fall further as companies choose to sacrifice margins for more traffic.

THE UPSIDE:

There’s already been significant damage to much of the consumer stock universe. The market is a discounting mechanism, it’s already well on its way to discounting extreme outcomes and some of the best brands, in the most important spending categories are now trading at some of the most attractive levels we have seen in 2 decades. I suspect some of the recent selling is early tax-loss harvesting and will reverse later this year but the question every opportunist should be asking today:

“WHICH MEGA BRANDS ON SALE DO I NEED TO START BUYING?”

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