Will The American Shopper Keep the Bull Alive?

First, a disclaimer: I rarely set foot in retail stores. I hate to shop, even online. I simply don’t have the patience for it. My wife Carole does most of the shopping for our family. It’s a “hunter-gatherer” thing, I guess.

But as a financial analyst, I’m deeply aware of how retail shopping is vitally important for the economy and stock market — especially under today’s uncertain investment conditions.

Since the end of World War II, any investor who bet against the desire of Americans to go shopping during a recovery ultimately lost the wager. Hence the time-proven adage on Wall Street: Don’t bet against the consumer.

In the U.S., consumer spending accounts for about 70% of gross domestic product (GDP), providing the growth engine that has pulled the country’s economy out of most downturns for the past seven decades.

So you think baseball, or maybe football, is the national pastime? Nope. It’s shopping. And America’s love affair with shopping just might keep this bull market alive a bit longer. The markets have decided that the U.S. is headed for a recession, but no one told consumers.

Negative trends suggest that consumers should be in retreat right now. Global economic growth is sputtering. In the U.S., manufacturing activity and construction spending are slowing. Political dysfunction is worsening; Robert Mueller’s scheduled testimony in front of Congress on July 17 will surely sharpen combat in Washington. Strife is intensifying in the Middle East and the U.S.-China trade war shows no signs of abating.

And yet, amid the turmoil, the American consumer is hanging tough and remains in a mood to spend. As the chart shows, consumer confidence is buoyant:

Source: Conference Board (as of 6/17/2019)

That’s because there’s also plenty of good news to counterbalance the bad. Unemployment stands at a 50-year low, U.S. GDP growth in the first quarter came in stronger than expected, interest rates remain low, the Federal Reserve has signaled a dovish tone, wage growth has picked up, inflation remains under control, and summer 2019 gasoline prices are forecast to be lower than they were last year.

As reflected by robust retail sales in May, the U.S. consumer is unfazed by the trade war and other headwinds. The ascendancy of consumerism is a global phenomenon. In the developing world, disposable incomes are rising in tandem with consumer sophistication. According to the Boston Consulting Group, China and India will be home to about one billion middle-class consumers by 2020. Emerging markets also have populations that are younger, and hence freer spending, than those in developed countries.

This boom in the global middle class will translate into a huge increase in spending for basic consumer staples that most North Americans and Europeans take for granted.

At the same time, the rapid growth of e-commerce appears unstoppable. Market research firm eMarketer projects that total e-commerce sales in the U.S. will amount to $600.6 billion in 2019, a year-over-year increase of 15%. According to eMarketer, e-commerce sales in 2018 accounted for 10% of all retail sales in the U.S. This figure is expected to reach nearly 14% in 2021.

Nothing lasts forever…

As of this writing on Thursday morning, the three major U.S. stock indices were trading in the green. Fears of trade war and recession seem to be taking a back seat to FOMO (Fear of Missing Out).

So why worry? Well, for starters, economic recoveries eventually end and this one is long in the tooth. Most recoveries last on average about eight years. If the U.S. makes it past July 1 without a recession, the current economic recovery will turn out to be the longest in American history (see chart, released June 26 by the research firm Statista).

According to a recent survey by Duke University, nearly half of U.S. chief financial officers see a recession within the next year. Meanwhile, the New York Fed’s recession probability model, based on the Treasury yield spread, has spiked upward recently and hovers at a 30% chance of a recession in the next 12 months.

Don’t expect corporate earnings to come to the rescue. From an earnings growth rate of more than 20% in 2018, consensus estimates call for declines in the second and third quarters of this year, with a modest rise in the fourth quarter. After three consecutive increases, the Conference Board’s Leading Economic Index was unchanged in May.

How severe will the downturn get? Consumer resilience indicates that we could be in for a soft landing rather than a hard one.

The crux is employment. As long as jobs are plentiful, consumers are more likely to keep spending.

Look at the following chart. The blue line is U-3, the more widely reported unemployment rate, which currently stands at 3.6%, its lowest level since 1969, when Richard Nixon was in the White House. The red line is the less reported U-6 rate, which includes those marginally attached to the labor market and those employed part-time for economic reasons. Both lines are at multi-year lows.

Investing moves to make now…

With an economic downturn on the horizon, how should you invest?

According to Ned Davis Research, the utilities, consumer staples, and telecommunications sectors have outperformed in the 12 months leading up to the start of a recession, which means they’re the smart places to be now. Among the big winners in 2019 have been retail stocks and the rebound in the sector should continue for the rest of the year.

Read This Story: Your Next Moves in This Mixed-Bag Market

Rotate into stable companies that provide services that are consistently used regardless of market or economic conditions. Consumer staples and utility stocks are prime examples.

Spread your portfolio among large-cap, mid-cap, and small-cap stocks. One often ignored move is to invest in mid-caps, which provide greater growth potential than large-caps but less risk than small-caps. Above all, reduce your exposure to overpriced, mega-cap momentum stocks that get a lot of fawning media coverage. When it comes to value stocks in recession-resistant sectors, it’s time to shop ’til you drop.

Questions about sector rotation? I welcome reader letters: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.