You can’t simply check consumer health with a stethoscope. What you need is the analysis of seasoned experts with their fingers on the pulse of the consumer.

From Thrivent Asset Management, welcome to this special episode of Advisor’s Market360^™, a podcast for you, the driven financial advisor.

Consumers drive the U.S. economy. In fact, they are responsible for about two-thirds of the country’s economic activity. In other words, as the consumer goes, so does the U.S. economy and the markets.

There are many factors that influence the health and happiness of U.S. consumers. Some are tangible, trackable metrics, like jobs and wages. Other factors are harder to track as they are driven by emotions and perceptions that may or may not be in alignment with reality. So, to get an accurate gauge of consumer health, we need experts who can perform a full body scan and interpret the images. Fortunately, Thrivent has the right team for the job. Today, we are joined by Steve Lowe, Chief Investment Strategist, Eric Johnson, Equity Consumer Research analyst, and Tracey Pamperl, Director of Investment Grade Research.

This episode is longer than usual, so buckle up. Here’s what’s ahead: we’ll start with the impact of COVID and the stimulus response, then the ensuing inflation. We’ll hear about consumer spending and its interplay with interest rates. Debt, housing, jobs and confidence are major themes we’ll explore, then we’ll end with a broader economic outlook from each of our three experts.

Let's begin our consumer health exam…

When we consider the factors that have the most impact on consumers, we focus on several areas: jobs, wages, accumulated wealth, the cost of goods and services, and debt. Historically, these factors tended to go in somewhat predictable cycles. But then, the pandemic happened, and many factors that influence consumer health changed radically. Here’s Johnson:

(Johnson) “To take a step back, how we got here, the late 2010s, you had corporate tax reform that lowered the corporate tax rate. Many corporations paid bonuses to employees during that time. Then you also had individual income tax cuts that set the stage for a pretty strong economy in the late 2010s running into COVID. Then, we dumped a ton of stimulus money into the economy. We lowered interest rates. Our interest rates fell significantly. Those poured gasoline on the spending fire. The last four years of spending has been quite strong on an absolute and a relative sense compared to prior years. But the volatility we've seen within categories has been more pronounced than we've seen in decades, really.”

Lowe had this to add about the impact of the pandemic stimulus programs:

(Lowe) “So this cycle is very different than in the past because we threw trillions of dollars into the economy and that supercharged spending both on goods and services, particularly goods to start out, but that impact is fading. Now savings are largely depleted, the economy has slowed and we're facing more headwinds.”

As Lowe mentioned, consumers are facing headwinds. But what are they? Let’s start with a persistent problem: inflation. Here’s Lowe:

(Lowe) “But I think what's really important is this huge headwind that consumers face over the last few years is starting to taper off, and that's inflation. In other words, inflation eroded their buying power. So, wages didn't keep up and they fell behind. And the level of prices remains very high. So that's called real income. In other words, income after the impact of inflation. And it was deeply, deeply negative in 2021 and 2022, but now it's starting to reverse. But we've seen stress in the consumer market. You have rising delinquencies. That impacts credit cards, autos, and mortgages are all going up, but they're not particularly high versus long-term history. But some are clearly struggling to repay their debt right now.”

That being said, Lowe is seeing some hopeful signs…

(Lowe) “Overall, I think we see the consumer in good financial shape. They're willing to spend. There's some caution. But they have this tailwind now that didn't exist before, which is lower rates. I think that will help going forward in particular as it makes large ticket items more affordable and should help the housing market.”

As Lowe mentioned, another persistent issue affecting consumer health is interest rates and their effect on buying power. Pamperl explains:

(Pamperl) “The high interest rates right now do have an impact on the consumer, and where we're really seeing it is on big purchases that you typically have to take out a loan for. So, think of a large remodel, so a kitchen remodel, large purchases like on appliances, on furniture at this point. So, we are seeing a dial back in that kind of spend. Credit card debt though at this point is starting to accelerate. And at the beginning of that it's a positive because it means the consumer spending. What we're starting to monitor though is if it's getting to a concerning level, because if you're having to put a purchase on a credit card right now the interest rates still really high. Does it get to a point where the consumer can't afford to make that payment? So, monitoring what's happening with delinquencies. And delinquencies not being able to make your payment after 30, 60, 90 days is how they measure it. And delinquencies are increasing right now, but they're back to about a pre-COVID level. Does it keep increasing and does it get to a concerning level that we really get concerned about the consumers, what we're monitoring?”

Our guests had a quick conversation about credit card debt:

(Lowe) “Yeah, it's really hard to carry credit card debt because right now you're paying about 22% interest on the average and that adds up very, very quickly.”

(Johnson) “And that's up from 15% generally over much of the last decade prior. So that's a significant hundreds of dollars on your average balance increase year over year the consumer has to manage.”

(Pamperl) “Yeah, and that's a great point. So, if we can come down from that 22% to maybe that more normalized level, we actually could have a positive in consumer spend. One, if you have to take out that loan for a necessary purchase just naturally it'll be a little bit easier to pay it back if interest rates come down. Also, if anyone's been sitting on the sidelines and not wanting to take out that loan for, like I said, that kitchen remodel, it may bring people back into the market and interest rates are down. Yeah, let's go ahead and do that remodel. So overall, it actually could spur some consumer spending once rates start coming down which would be a positive read-through for the economy.”

Of course, interest rates are a big factor in housing prices. Mortgage rates are something that consumers, and our experts, pay very close attention to. Here’s Lowe’s thinking on the subject:

(Lowe) “It's been a really tough environment because mortgage rates shot up. Existing home sales have remained very depressed, and that's a function that they got a lot less affordable, and partly due to what's called the lock-in effect. So, people had low cost, and they have low-cost mortgage still from the pandemic when mortgage rates were as low as 3% or so. And once the Federal Reserve [or Fed] started raising rates, mortgage rates shot up pretty significantly which makes housing less affordable. So, 8% was the peak of it and it's still around 6%. Having a house payment from 3% to 6% makes housing less affordable. We expect that to go down as the Federal Reserve lowers rates that should spur some activity, particularly in existing homes. That's really important for the economy because if people buy a house, that generates more activity.”

Another factor affecting home prices is the lack of homes for sale—a supply constraint. Here’s Johnson explaining why this shortage came about.

(Johnson) “The U.S. has also been in the supply constraint. There's a few factors here. You have the 2010s, you saw less homes built than in prior decades new supply in the market. You had the millennials finally came out of their parents' basement a little bit later than prior cohorts, but they have moved out and our household formation is picking up. And so that has driven more demand. And then you also have the older generation. It's been easier to age in home not only because of technology making it easier, but it's cheaper than home healthcare, nursing home care, which has gone up quite a bit above general inflation. And so those services have gotten more expensive. Older generations have aged into homes, constricting housing supply on the open market.”

Homeowners aren’t the only affected party. There are many renters across the country who are also affected by inflation and interest rates. Again, here’s Johnson:

(Johnson) “A third of the country or so rents. They as asset prices, real estate prices went sky-high, those consumers quickly got passed price hikes by landlords very quickly. So, their cost of living in '21, '22, you had double-digit rent inflation in a lot of cities. And so that was immediate strong impact on those households. And that's the key takeaway. All the cost-of-living pressure hit them right away, whereas homeowners it was more elongated and drawn out because of that locked mortgage rate effect. And going forward is the consumer rolls into new existing home turnover, they're going to lock into higher rates and that's weigh on discretionary capacity. And the second piece for homeowners why it's a bit lagged is because insurance rates generally lag and property taxes. So, you're seeing that start to build and escrow accounts are having to be bumped up because of those higher costs. So, it is coming through more elongated and more muted for the homeowner than it was for the renter, but those are the two dynamics. So, it absolutely affects consumer spending. And both groups have had headwinds, it's just played out a little bit different in terms of timing.”

Pamperl offered some examples of the interesting dynamics at play in today’s housing market.

(Pamperl) “I mean, just unfortunately these high mortgage rates are a negative for any potential home buyer. And it's across the board. So it could be that first-time home buyer that wants to get their first home, it's just very expensive. If someone's in maybe a smaller home, they're outgrowing it as they're having children, they want to upsize get more square footage, same thing, it's going to be a lot more expensive because the house is more expensive and the mortgage rate’s more expensive to upsize. And then there's this opposite thing that if you're becoming an empty nester you want to downsize. If you have a mortgage on your house right now, even though it's much larger than maybe what you need or want at this point, if you're going to take a mortgage out on a smaller square footage home or townhouse actually your mortgage payment may actually go up. Another interesting dynamic is usually when mortgage rates go up, housing prices come down some to offset each other so that the mortgage payments still stay somewhat equal. And we just haven't seen that this time around. And that's because of the supply-demand dynamic, because we're not having both new housing and then existing housing isn't coming on the market the way that we're used to. So, we have home prices have actually stayed elevated. We have the mortgage rates while they're not at the peak, they've come down, but they're still very expensive.”

Pamperl added that it's this double dynamic of high mortgage rates and constrained supply that, unfortunately, makes housing unaffordable.

As we mentioned at the beginning of the episode, there is data that helps our experts get a handle on consumer health. Pamperl explains one index she watches.

(Pamperl) “One of the indexes we watch closely at Thrivent is the Housing Affordability Index. And what that looks at is for the average consumer and their wages that are coming in, can they afford an average mortgage? On an average size house, at the mortgage rates, at the housing prices. What that comes in at is if that ratio comes in at 100, that means they have as much money as they need for that monthly mortgage payment. If it's over 100, it means they have a bit more than they need, so that's a positive. Conversely, if it's coming in under 100, they don't have enough. So again, the affordability index. We've been running under 100 in the mid-90s for almost three years now. So very explicit example of it's not affordable to the general U.S. consumer to buy a home right now.”

Based on the first half of this episode, it would be easy to conclude that there’s no good news for the consumer. However, our experts provided some positives that could buoy spirits. For example, fixed rate mortgages. Johnson explains:

(Johnson) “Housing is pretty important, both mathematically and psychologically. For most consumers, the overwhelming majority, in fact, it's their largest asset. And so, perceptions around price levels really influence not only mathematically how much they can spend, but psychologically, how much willing they're to go out and extend. There's some unique wrinkles here, too, because the U.S. consumer in our economy, in our housing market now, we have far less variable rate exposure than we have had in prior cycles, most recently the global financial crisis. Then also relative to other global economies, Canada, Australia, much more variable rate sensitive. They've seen a slowing of consumer spending at a faster clip than we have because those rate hikes are transmitting to them much quicker.”

Another positive is wages. According to Lowe, wages are actually up when adjusted for inflation. Johnson agrees that wages are up and that means the capacity for spending is also up—a key driver of the economy. Johnson goes into a bit more detail about capacity:

(Johnson) “In terms of assessing capacity, it starts with three components: job growth, wage gains, and then hours worked. Those three generally are all tracking pretty good. If you step back to the front line, the entry level of the economy, the retail markets, the restaurants, retailers, the job market there, job openings have come down there below pre-pandemic levels into the mid-2010s levels. It would be indicating that slack is building somewhat in the labor market. Turnover has gone back to pre-pandemic levels for most of the companies we speak to. Consumers are hanging on to jobs. They're not getting paid, signing bonuses and big premiums to switch jobs. And so, they're hanging on to what they have. But at the end of the day, we're also still seeing wages grow at 3% to 4%, which is a nice happy medium for the economy, for companies to manage and for the consumer to spend above inflation if we trend into this low single-digit level year-over-year from inflation. So that's all positive.”

Looking ahead, we wanted to get a read on what factors our experts are watching as they continue to assess consumer health. Let’s start with Lowe and employment:

(Lowe) “You can look at consumer confidence surveys, and there's one done by the conference board that focuses on jobs, and it's held up well. There's not a lot of concern about losing a job. I mean, it's gone up, but it's low versus history. People aren't that worried about the ability to find a job if they lose job. But I expect those concerns to increase over time because the job market is slowing. We've had this huge shift from during the pandemic. During the pandemic, the main issue was a shortage of labor, and there are too many jobs. If you looked at it, there was two openings for every unemployed worker. That made it very easy to switch jobs. It made it very easy to get higher pay by going somewhere else. That was good for consumers because their pay went up. That's changing pretty quickly right now. You can look at the number of job openings, and that's fallen very rapidly, mainly by people hiring less, not as much by layoffs. But now it's in balance. It's about one job opening for every unemployed person, and that's back to about where it is in the long run.”

Often, a consumer’s confidence is a matter of perspective. The small choices that they make signal their feelings about where they think their personal finances are heading. We will let Johnson explain:

(Johnson) “All this boils down to the consumer perspective. We're starting to see them increasingly make choices, whether that's down trading in the grade of meat or produce they're buying at the grocery store, whether it's deferring auto maintenance, brakes, rotors, tires, you're seeing some of that activity build. Then one of the clearest signals we watch is the spread between off-price retailers, think like a TJ Maxx in their same store sales, relative to a full-price retailer like a Macy's. You're seeing pretty strong divergences there, favoring the value retailers, which would be indicative of the consumer looking to manage their budget, potentially bracing for what's around the corner. And so, these are signals we will continue watching in the next year.”

Pamperl has a similar perspective, but she is framing it as consumers being more cautious. Here’s her thinking on the subject:

(Pamperl) “I think consumers right now are being cautious, and that's on both discretionary and non-discretionary spend. What's been very clear, which has been a little bit of a shift in dynamic this year is before we were talking about just the lower income consumer being really focused on value. What's shown through this year that we're hearing from the companies that the investment grade research team covers is that really, it's across the spectrum now. Consumers are seeking value. We've seen it very clearly in a couple of different ways. It's that trading down impact. Going into the store, and right now, not everyone's needing that name brand. They're willing to go generic or store brand to save a little bit of money. They are smaller basket size. That can mean take your grocery cart, take your literal basket when you go into a store, it's less items in the basket. That's one because prices are still elevated, even though inflation has come down. The overall price of that good is more expensive than it used to be. Consumers are also going, you know what? I'm just going to buy one of those. They're buying what they need right now, and they're willing to go back to the store more often, willing to go closer to or right after they get a paycheck.”

Another concern for Lowe is the erosion of buying power. He explains:

(Lowe) “The bigger issue, I think, for pay checks has been the erosion of buying power, as we mentioned before, because consumers fell significantly behind. And if you look at prices now, they're still up about 20, 21% above trend from where they were before the pandemic. And consumers had negative wage growth for two years. And so, the buying power permanently eroded.”

Johnson also expressed some concerns about household savings rates and consumer debt levels.

(Johnson) “We look to areas that U.S. housing savings levels are at 50-to-60-year lows, not quite there, but pretty close to where we've been. That's a concerning sign of stress. We also look at consumer debt levels which are increasing, the financing that debt is increasing. These are concerning factors that could be a drag on consumer pay checks.”

There is one additional thing that Johnson feels may erode consumer health and that’s credit card debt. He explains:

(Johnson) “Back to credit cards for a second. We've seen delinquencies had increased. Overall, they're not too bad, but where they're really pronounced, both autos and credit cards are in the younger cohorts, where those are the levels where we're starting to get closer to prior recessionary periods, which is indicative of the whole dichotomy where if you had assets, you had net worth before 2022 locked in, you were able to refinance that at lower rates, you benefited from inflation. Whereas if you're earlier in your earning career or earlier in your household formation, those dynamics were actually quite a bit of a headwind for you. And so, you're seeing a bifurcation in the economy from that perspective. And then the other thing I'd note that is a sign that you don't generally see in a strong backdrop for consumer is 401k hardship withdrawals tracked by Fidelity and Vanguard. Those are up 2 to 3X the rate. It's still low levels in absolute, but 2 to 3X what they were pre-pandemic. We had some pandemic regulations that made it easier to access those funds in a less onerous way, but they're still not easy, there's some requirements you have to do to manage that penalty-free. I would think that's indicative of consumer stress. You generally don't see people tapping that unless there's a real tough reason for them to do so.”

As was stated earlier, as the consumer goes, so does the U.S. economy and markets. So, what does the current state of consumer sentiment portend for the markets? Here’s Pamperl on how the retail sector is responding to consumer sentiment:

(Pamperl) “I think the retailers that have been the most successful are the ones that can offer the consumer whatever they want. So, a consumer has three ways they like to shop. And it's, I want to go into the store, I want I want to order online and pick up in a store, or I want to order online and have it shipped to me. If it was a healthy company that was able to invest in the technology that supports those three ways for the consumer, I feel like those companies are doing the best right now because the consumer wants to shop the way they want.”

With access to three experts, we would be remiss if we didn’t take the opportunity to get their outlook on the markets more broadly. We will start with Lowe.

(Lowe) “If you look at credit markets like high yield bonds and investment rates, those are also good. The areas that have laid behind are cyclical sectors because there's still this concern over the economy and still concern over there might be a recession. And I think we're at this inflection point right now where there's a lot of uncertainty. There are signs of slowing. Unemployment is going up. And if you look, historically, economies can be doing really well. Same thing with the jobs market. And then they can go nonlinear. In other words, they can fall off a cliff very quickly. But overall, I think the economy will remain relatively solid. We have an internal index that we track the economy with, and it got to pretty deep recessionary levels where it's always been in a recession. But it's come down a lot and more to a soft landing. And we expect more volatility going forward, but we also expect the economy to hold up relatively well. Our forecast is not for a recession, but for more volatility overall. What does that mean for investors? It means to making a balanced approach, staying in the market, be sure to have fixed income, because if the economy does deteriorate, rates are going to go down, and that helps fix income. You still want to be in the equity market. But the important thing is to stay in the market.”

And here is what Pamperl is anticipating…

(Pamperl) “Yeah, the corporate bond market, quite frankly, has performed very well, but I think it's been very focused on macroeconomic indicators, and then what's the read through to the Fed potentially cutting rates? It's also had an increased sensitivity to any individual company, whether it's earnings or at a conference, any comments around the consumer, and what's that read through? Is that a specific issue for that company, or is there a broader issue across the industry and to the economy? For the consumer focus names, I think it is more of a mixed bag at this point. Some are benefiting from consumer shifts in behavior, some are not. Retail sales have been quite strong, but I do think we're about to face more headwinds than tailwinds at this point.”

And we will let Johnson have the last word on where the markets may be heading.

(Johnson) “So equity markets are very focused on the debate and have been for 2-3 years, month to month, iteration. Is the consumer weakening? Can the consumer spending levels remain durable here? Or are we having signs of increasingly fragile backdrop? And so, this debate that's been going on has been favoring higher quality, better capitalized companies, often larger caps, with higher margin rates. And so, the lower quality names with more leverage on the balance sheet, lower margins, lower reinvestment capacity, those names tend to perform their best when we think consumer spending is going to accelerate. That's not really been a discussion point on the table in the last couple of years. It's more, can we hang in there or do we worsen? And so that's been to lay the land in equities. And ultimately, the market is highly focused on unit volume recoveries in these durable goods categories as if we get interest rate cuts. So, you've seen stocks start to front run expectations for volume in flooring, furniture, remodeling, autos start to accelerate in anticipation that cuts will deliver volume acceleration. That's something we're going to need to see to continue to support equities in some of those areas. But from a consumer perspective, ultimately, if jobs hold up, it's difficult to bet against the U.S. consumer. If you're going to watch one metric over the next 12 months, that's where I point you to.”

We hope you enjoyed this special episode on consumer health. Once again, we would like to thank Steve Lowe, Eric Johnson and Tracy Pamperl for their enlightening insights. What did you think of this episode? Email us at podcast@thriventfunds.com with your feedback or questions for our experts. Want more episodes of Advisors Market360^™ and other market and investing insights? Visit us at thriventfunds.com, where you can learn how we can partner with you, the driven financial advisor. Bye for now.

(Disclosures)

All information and representations herein are as of September 17, 2024, unless otherwise noted.

Past performance is not necessarily indicative of future results.

Investing involves risks, including the possible loss of principal.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.

This podcast refers to specific securities which Thrivent Mutual Funds may own. A complete listing of the holdings for each of the Thrivent Mutual Funds is available on thriventfunds.com.

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