The economic recovery rests on getting consumers to spend. It won't be easy.

  • By Reshma Kapadia,
  • Barron's
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Yet another economic indicator is now the worst on record: On Thursday, the Commerce Department reported that consumer spending dropped 7.5% in March, the biggest one-month drop since the government began tracking in 1959. While economic indicators across the board are problematic, the consumer spending figures loom large—the global economy simply cannot recover without the consumer.

The $22 trillion U.S. economy rests on people buying stuff; consumer spending accounts for 70% of total economic output. How, where, and when people choose to spend their money from here on out will shape companies’ reopening plans—and serve as a harbinger for the broader economic recovery.

Past recessions have typically started elsewhere—like in energy or banking—and then bled into the consumer as job losses piled up. But consumers are on the front lines of this downturn, and the sectors dependent on their spending—travel, leisure, retail, restaurants—have been among the most battered as governments pause their economies to contain the pandemic.

Reopening won’t be easy; governments and companies must walk a fine line between reopening and avoiding another wave of Covid-19 outbreak. Some companies, such as Starbucks (SBUX) and Macy’s (M), already have plans to reopen stores beginning next week. But it is far from business as usual in terms of operations, and retailers will also likely find a much-changed consumer, a byproduct of strained budgets and trepidation about the future.

Some 30 million Americans have lost their jobs in six weeks, dealing a sizable blow to household budgets. The jobs most immediately at risk are in the areas you’d expect—accommodation, food services, retail, construction, and manufacturing—but the fallout could be much broader. More than a quarter of 100 large U.S. companies tracked by nonprofit research firm JUST Capital disclosed furloughs or voluntary leave at low to no pay as of April 21—quadruple the number on March 24. White-collar workers, including those who can work from home, are among those seeing paychecks cut or deferred—an unusual phenomenon that suggests the crisis could hit the spending of various income groups, says Gregory Daco, chief U.S. economist at Oxford Economics.

What’s more, Americans have little buffer: More than half of U.S. households don’t have any emergency savings to tap in a crisis. Even a quarter of households earning more than $150,000 lack one.

Credit card balances were already climbing ahead of the pandemic, hitting $1.1 trillion in February; the ratio of debt to net worth in the middle class was higher than for other groups, according to Geoffrey Sanzenbacher, a research fellow at Boston College’s Center for Retirement Research. And now Americans are missing payments, with several credit companies bracing for fallout. American Express (AXP), for example, has tripled its credit loss provisions.

There’s also a psychological impact. As stores and restaurants reopen, consumers’ experience with the coronavirus will affect their risk tolerance for venturing out, says retail analyst Dana Telsey, head of Telsey Advisory Group. Those older than 65 represent roughly a fifth of total consumer spending and may be among the slowest to go out again as they are among the most vulnerable to the virus.

Sheltering in place has also achieved what financial experts have long tried to do: Force savings, as people—even those not directly impacted by the fallout—have been unable to take trips, hit the mall, or grab their venti lattes at the cafe. The experience may lead to its own behavioral shifts.

“No one has the urge to spend less on their own, because then they feel deprived,” says Robert Frank, an economist and Cornell University professor. “When everyone spends less, you don’t feel deprived.” He sees the crisis as offering an opportunity for Americans to reassess their spending.

That has already proven true: For the week ending April 12, credit card spending was down 34.4% and debit card spending was down 14.6% in the states hardest hit by the pandemic, including California, New York, New Jersey, Illinois, and Louisiana, according to PSCU, a nationwide credit union servicing organization. But spending in the eight states without “stay at home” orders wasn’t much healthier, with credit card spending down 29.5% and debit card spending down 11.7%. Only a fifth of Americans surveyed by Gallup said they would resume normal daily activities “immediately”; 70% said they would “wait to see what happens with the spread of the virus before resuming” and the rest said they’d limit social contact “indefinitely.”

Consumers surveyed in France, Germany, Italy, Spain, the U.K., and the U.S. were spending 25% to 30% less than before the virus as of April 21, according to Deutsche Bank. European retail chains have warehouses full of collections that are now out of season and fashion, and the cost of storing it all for another year exceeds their low profit margins. When McKinsey surveyed German consumers in mid-April, less than a quarter were optimistic about an economic recovery.

Once the health crisis moderates, respondents said they plan to curtail some in-person activities and reduce their online grocery purchases. Staying in could cause broader pain: Eating out accounts for 60% to 80% of all food service revenues, according to a March report by Rabobank.

China has reopened much of its economy, but consumer spending and retail sales are still depressed—even after China sent vouchers to households to entice them to go out and spend. Another survey by McKinsey of Chinese consumers found 30% used less skin care and bought less alcohol, and more than half used less makeup. But among wealthier respondents in China’s bigger cities, 30% bought more skin care than prior to the crisis—an indication of the trend toward health and wellness that many analysts expect will accelerate in the U.S. as well. Baby boomers in particular may be more careful in how they re-engage with society, which could lead to less spending on travel and more on their homes or health and fitness.

A reluctance to go out until there is a vaccine or treatment will hurt the sustainability of consumer-oriented companies and their labor force, says Jack Kleinhenz, chief economist for the National Retail Federation.

In the U.S., Oxford’s Daco estimates half of consumer spending could be at risk. Once the economy stabilizes in 12 to 18 months, consumer spending will likely be a smaller slice of the economy by a couple of percentage points.

Americans, however, do love to spend, and we are optimists by nature. Bespoke Investment analysts found a ray of light in the Conference Board’s index of consumer confidence, which fell to its lowest reading since mid-2014. Bespoke noted that the most surprising part of the report was an increase in consumers’ expectations for six months in the future, hinting at a pent-up desire to spend.

But pent-up demand—an invocation used to will a speedy economic recovery—isn’t enough. No matter how many people are eager to return to their spendthrift ways (or how many can still afford to), it is clear that companies are going to have to adjust how they cater to consumers. And for many, those adjustments will come at a cost.

Getting customers in the door could require profit-eroding changes—such as flying less-full airplanes and reducing seating capacity in restaurants and theaters. Further complicating the situation: This is when retailers order for the crucial back-to-school and holiday shopping seasons, an already-challenging exercise in predicting demand that is further complicated this year by uncertainty about supply. “I’m looking at the profit dynamics,” Credit Suisse chief U.S. equity strategist Jonathan Golub says of the broader market. “Even if consumers want to go back, profits will take three years to get fully back to normal.”

Investors have some options, depending on their level of optimism. Bank of America consumer goods analyst Robert Ohmes looked at how companies would fare in three scenarios. If there is a sustained closure of retail and restaurants through the summer and into the end of the year, possibly due to a second wave of infections, Ohmes and his team expect consumer staples stocks and “essential” retailers with open stores to outperform, as well as discretionary companies that have good liquidity and can grow their online sales. That includes Walmart (WMT), Nike (NKE), Costco Wholesale (COST), Lowe’s (LOW), Target (TGT), Urban Outfitters (URBN), and Dollar General (DG). Relative losers in this scenario would include mall-based retailers “with liquidity challenges,” such as Macy’s, Gap (GPS), Signet Jewelers (SIG), and Nordstrom (JWN), and any store without much of an online presence.

If stores reopen but must abide by “severe” social-distancing, Ohmes expects a divergence in performance. Sales for companies with the least impact from such guidelines will rebound the strongest; staples like Procter & Gamble (PG), Mondelez International (MDLZ), and Kimberly-Clark (KMB), for instance, and companies that offer an easier one-stop, in-and-out experience are also well-positioned. The list of relative winners in this scenario include Lululemon Athletica (LULU), Estée Lauder (EL), Advance Auto Parts (AAP), fast-food chains like Domino’s Pizza (DPZ), Wendy’s (WEN), and Jack in the Box (JACK), and discount retailers like Dollar General, Ollie’s Bargain Outlet Holdings (OLLI), as well as Floor & Decor Holdings (FND).

And if stores reopen, but there is a deep recession, Ohmes looked for companies that fared relatively well during the 2008-09 downturn and that could also benefit from consumers getting stimulus payments.

That includes fast-food chains like McDonald’s ; auto parts companies like AutoZone (AZO) and Advance Auto Parts; dollar stores like Dollar Tree (DLTR) and Big Lots (BIG), as well as the likes of Walmart, J.M. Smucker (SJM), and Spectrum Brands (SPB).

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