One of the big takeaways from the most recent retail earnings season was the ongoing strength of the higher-income consumer. From Nordstrom to lululemon and even Williams-Sonoma , wealthier Americans weren’t pulling back amid higher inflation.
In one respect that makes sense, given that they are more insulated from the need to budget, and tend to have higher reserves to dip into if they want to keep spending. Yet Morgan Stanley warns that even this coveted cohort could start feeling the pressure.
The firm’s consumer analysts took a look at previous economic downturns, and note that looking as far back as the 1990s, the Great Recession was the only prolonged period of year-over-year declines in average annual spending among the top 20% of American earners. That’s likely because not only were their balance sheets squeezed by financial markets, but nonfinancial assets, such as housing, also lost value, causing them to pull back.
The good news is that housing prices don’t appear to be in danger of falling into the red, as they did then, which cushions the blow of recent stock-market declines. In addition, the wealthiest 20% of households have $1.5 trillion in excess savings they can access. That leads the firm to believe that “while consumer discretionary spending may slow in 2022/2023 (having an adverse impact on pockets of consumer discretionary spending), the top 20% of U.S. households are likely to continue to spend.”
Yet even if we’re not about to repeat 2008, the analysts argue that “the risk to high-end consumer spending is rapidly rising,” but the market isn’t pricing that in.
The problem is we’re dealing with inflation at 40-year highs—much higher than in previous recent recessions—and consumer confidence, as measured by the University of Michigan, is at a 30-year low. That increases the chance even higher-end consumers could pull back meaningfully; still, even if the firm’s more mild base case plays out, there could be more pain for the market.
Ultimately, however, not all retailers will feel that pain equally. Morgan Stanley argues that among off-price and specialty retailers, TJX ( TJX ), Burlington Stores (BURL), Ross Stores (ROST), Gap ( GPS ), Skechers (SKX), and Kohl’s (KSS) look better positioned in the firm’s base-case scenario, while Costco Wholesale (COST) appears to have the advantage among broadline and food retailers. McDonald ’s (MCD), Yum! Brands ( YUM ), and Domino’s Pizza ( DPZ ) are the restaurant picks.
Write to Teresa Rivas at email@example.com