Looking into 2019, prospects for consumers of all income levels look bright, in my view. With unemployment continuing to drop we are seeing lower rates of "underemployment." Also, corporate announcements of significant job cuts have been less frequent. In fact, the opposite has been occurring, as previously disenfranchised workers are being drawn back into the workforce. Despite an uptick, inflation remains relatively low, and, importantly, I believe consumers in all income brackets are benefiting from wage increases.
I’m especially upbeat on the outlook for lower-income consumers, as a substantial number of Americans recently received their first pay raise (adjusted for inflation) in more than 20 years. Lower-income earners began seeing a rapid and substantial pickup in wages in 2016, which is a significant change from the muted, or in some cases negative, wage growth they had experienced earlier in the post-recession recovery. Despite an initial downtrend in 2018, nominal wage growth for these groups recently picked back up and remains compelling on a rolling basis (see the chart below). While the higher-end earners experienced sharp increases in wage growth starting in 2010, most workers in the United States—especially lower-income cohorts—still remain in the early years of wage increases.
Moreover, evidence suggests to me that this trend is set to accelerate. Supply/demand dynamics and the overall labor market are very tight, with low levels of unemployment across the range of education and income-earning levels. Increasing minimum wages should also benefit lower income earners. Notably, minimum wages increased nearly 5% in 2017, more than double 2016's rate of 2%. Lastly, recent corporate and personal tax cuts also stand to amplify the effects of these positive trends. First, corporate tax cuts are driving companies to reinvest tax savings into labor, with a lengthy list of bonuses and pay increases announced by nearly every large company, increasing the upward pressure on wages across a very tight labor market, in my opinion. Second, I think personal income tax cuts will drive an increase in after-tax earnings across the income spectrum. This combination of factors should help maintain a positive environment for wages.
Select industries stand to benefit disproportionately from the trend
Historically, lower-income consumers have had a very high propensity to spend increased after-tax wages on discretionary purchases. The last time lower-income workers saw inflation-adjusted wages rise was between 1994 and 1996, and several companies across select industries experienced accelerated growth in same-store sales concurrent with wage increases during this period.
Today's consumer environment is markedly different from that of the mid-1990s, particularly for retail, where disruption from e-commerce has completely reshaped the industry’s landscape. However, our proprietary research shows us which industries within the sector are uniquely exposed to lower-income demographics in current market conditions. Among them, I'm finding particularly compelling opportunities among dollar/discount stores and off-price retailers. Companies in these industries also tend to be relatively insulated from the seismic shift in consumer retail shopping patterns. Regional casinos, auto-part retailers, and quick-service restaurants are a few other categories I think have strong potential to benefit from an uptick in spending from lower-income earners.
Overall, I foresee a favorable backdrop for actively managed strategies in the consumer discretionary sector. Somewhat tempering my enthusiasm is the fact that inflation has ticked up along with interest rates. While the political backdrop remains uncertain, it seems consumers continue to accept this state of affairs, and current geopolitical tension and uncertainty are now considered "normal." The positives outweigh the negatives, in my view, and I am bullish on the US consumer in 2019 and beyond.
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