Brands Expert Discusses Why Pent Up Spending/Demand Continues to Build

We recently saw the primary driver of the U.S. economy, Personal Consumption Expenditures (PCE) plummet by the most on record. That’s what happens when 320 million people aren’t supposed to go out of their houses much and most physical stores are closed by the state and federal government. With the natives getting very restless, yours truly included, the most historic plunge in consumer spending is about to mean revert higher. Make no mistake, consumption will not return to pre-covid levels for some time and there’s a lot of variables driving that statement but when we see “historic plunge” in the news, it’s usually followed by something much less insidious. As the economy begins opening up at partial capacity and slowly, the pent-up spending will begin but in a very cautious way. There will be winners and losers and the strongest brands will likely get even stronger through this crisis.

If spending has been stopped then savings have likely been re-built. Logical and true based on the image below from the St. Louis Federal Reserve. While most consumers are currently cautious, those with secure jobs are seeing their household balance sheets getting a buffer via higher savings. Long-term that’s a great thing even if spending takes a hit short term. To be sure, with unemployment staying uncomfortably high for the next year, there will be stress on some households and a strengthening balance sheet from others. I expect low income families to continue to retrench and spend only on the essentials (Amazon, Costco, Walmart, P&G, J&J, Dollar General, Verizon, Roku, Netflix, etc.) with other households beginning to dip their toes into discretionary items (Lululemon, Nike, Apple, Visa, Mastercard, Starbucks, Target, Home Depot, Lowes, Chipotle, TJ Maxx, Adidas, Dicks Sporting Goods, Best Buy, etc.).

What will the rest of the year look like for spending?

I continue to believe spending will be lumpy and more concentrated this year versus most years. We have so much uncertainty that it’s hard to know how much of the normal spending habits will be able to be completed. I’m confident we all want to get on with our lives, particularly as summer approaches but it’s still unclear how the state and national governments will open the economy. My local politicians still can’t agree on whether to allow hikers and bikers on the trails and that’s an easy decision. There doesn’t seem to be much of a focus on logical strategy happening across the country so spending certainly shouldn’t be expected to be even over the next 90 days. One thing is for sure, online retail is sure to be the leading method for purchasing.

Short of the country being on lock down for another few months, the consumption component is sure to bounce back from the historically depressed levels we have just seen. Once we have this bounce though, I suspect consumption will level off for at least the next 3 to 4 months, while consumers get a better handle on how they are able to navigate through the economy and get back to their old lives. The job picture will be key to the consumption recovery. The good news: we all want to get back to something that more resembles normal and once we get a little momentum in that direction, particularly without many spikes in new virus cases, it can feed on itself in a positive feedback loop.

As we open the economy, we should probably expect a burst of economic activity from a combination of pent-up demand and pulling forward of the normal summer demand. It’s impossible to know what the PCE will look like over the next three months, but I suspect it will look better than the numbers from the above chart. Here’s the rub: the current quarterly earnings reports have largely been ignored as no one expects a positive tone or guidance for the rest of the year. Largely though, the results haven’t been as bad as the news flow might indicate because the quarter was only partially impaired due to Covid-19. Earnings estimates for the July quarter reporting window will be the real indicator of which companies have staying power and which ones could be terminally impaired. Beginning in July we get to see which brands have the most loyalty and which ones may have been riding a bull market wave versus have highly sustainable business models. I continue to believe now is not the time for broad ETF investing versus having a much more concentrated, scalpel-like approach. July will be the most important earnings season since the financial crisis of 2008/2009 from my perspective.

Which brands have reported surprisingly strong quarters this earnings season?

• Facebook & Google – ad sales were strong for the first few months then dropped off a cliff in March. April seems to have stabilized and both brands have stellar balance sheets and innovation drives their business focus.
• Johnson & Johnson – increased the dividend, working on a potential vaccine for Covid-19, consumer businesses held in their strong while medical devices were weak given elective procedures being pushed out for a while.
• Procter & Gamble – Solid dividend, strong organic growth, in-demand staples
• Roku & Netflix – Strong streaming video demand & expense control.
• Costco – heavy traffic, strong membership growth, consistent business trends.
• Microsoft – Barely a hint of an economic slowdown, video gaming strong, cloud computing strong, Teams collaboration business very strong, corporate computing remains stable.
• Spotify – strong subscription trends and listener engagement, growth focus remains intact.
• Amazon – exceptional quarter and pivoting into full growth mode again as they serve more customers.
• Apple – much stronger than people thought, there’s real demand online for the stay at home theme via iPads and Mac’s while a new, lower priced phone is sure to get traction. Strong dividend support, revenues and exceptional balance sheet.
• Mondalez – snacking demand was strong, and trends are stable and predictable.

Bottom Line:

Here are some bottom-line takeaway points to consider:

• We have just witnessed a historic drop in consumer spending via the Covid-19 shutdown.
• We should not expect spending trends to return in a V-fashion in the short-term.
• Savings rates will stay higher than normal, while uncertainty is high and then pent up demand will drive savings rates lower.
• Spending will rebound a bit this quarter as the economy opens up, then I expect some stabilization at lower than trend levels while we rebuild the workforce.
• July earnings will tell the world which brands are most coveted – these will be where we focus.
• The market will continue to reward the most relevant brands and punish the companies

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