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Recasting Our Rise and Fall of the Middle Class and Cash-Strapped Consumer Themes

Recasting Our Rise and Fall of the Middle Class and Cash-Strapped Consumer Themes

 

KEY POINTS FROM THIS POST

  • As we recast our Rise & Fall of the Middle Class into two themes – the New Middle Class and the Middle-Class Squeeze, which also folds in our Cash-Strapped Consumer theme, we are calling out Costco Wholesale (COST) shares as a top Middle-Class Squeeze pick, reiterating our Buy rating on the shares, and bumping our price target from $210 to $220.

At the end of yesterday’s Tematica Investing issue, I mentioned how at Tematica we are in the process of reviewing the investing themes that we have in place to make sure they are still relevant and relatable. As part of that exercise and when appropriate, we’ll also rename a theme.  Our goal through this process is to streamline and simplify the full list of 17 themes.

Of course, first up is our Rise & Fall of the Middle-Class theme that we are splitting into two different themes — which I know doesn’t sound like an overall simplification, but trust me, it will make sense. As the current name suggests, there are two aspects of this theme — the “Rise” and the “Fall” part. It can be confusing to some, so we’re splitting it into two themes. The “Rise” portion will be “The New Global Middle Class” and will reflect the rapidly expanding middle-class markets particularly in Asia and South America. On the other hand, the “Fall” portion will be recast as “The Middle Class Squeeze” to reflect the shrinking middle class in the United States and the realities that it poses to our consumer-driven economy.

As we make that split, it’s not lost on us here at Tematica that there is bound to be some overlap between The Middle-Class Squeeze and our Cash-Strapped Consumer investing theme given that one of the more powerful drivers of both is disposable income pressure and a loss of purchasing power. As such, as we cleave apart The Middle-Class Squeeze we’re also incorporating Cash-Strapped Consumer into it. It’s repositionings like this that we’ll be making over coming weeks, and while I hate to spoil a surprise as we say good bye to one or two themes, we’ll be saying hello to new one or two as well.

 

 

Why America’s Middle Class are Feeling the Squeeze

As both I and Tematica’s Chief Macro Strategist, Lenore Hawkins, have been sharing in our writings as well as our collective media hits, we’re seeing increasing signs of inflation in the systems from both hard and soft data points and that recently prompted the Fed to boost its interest rate forecast to four hikes this year, up from three with additional rate hikes in 2019. That’s what’s in the front windshield of the investing car, while inside we are getting more data that points to an increasingly stretched consumer that is seeing his or her disposable income under pressure.

According to LendingTree’s May 2018 Consumer Debt Outlook, Americans owe more than 26% percent of their disposable personal income on consumer debt, up from 22% in 2010. And just so we are clear, LendingTree is defining consumer debt to include non-mortgage debts such as credit cards, personal loans, auto loans, and student loans. These outstanding balances of consumer credit, per LendingTree, have been growing at a steady rate of 5% to 6% annually over the last two years, and this has it to forecast total consumer debt to exceed $4 trillion by the end of 2018.

Part of the reason consumers have been turning to debt is the lack of wage growth. Even as tax reform related expectations have been running high for putting more money in consumer pockets data from the Bureau of Labor Statistics revealed compensation for civilian workers rose 2.4% year over year in the March quarter. By comparison, gas prices have risen more than 24% over the last 12 months, and the average home price in the US was up more than 11% in April 2018 vs. April 2017. So, while wages have moved up that move has paled in comparison to other costs faced by consumers.

Then there’s the data from Charles Schwab’s (SCHW) 2018 Modern Wealth Index that finds three in five Americans are living paycheck to paycheck. According to other data, consumers more than three months behind on their bills or considered otherwise in distress were behind on nearly $12 billion in credit card debt as of the beginning of the year — an 11.5 percent increase during Q4 alone.

And it’s not just the credit card debt — mortgage problem debt is up as well, 5.2% to $56.7 billion.

As that debt grows, it’s going to become even more expensive to service. On its recent quarterly earnings conference call, Lending Club’s (LC) CFO Tom Casey shared that “Borrowers are starting to see the increased cost of credit as most credit card debt is indexed to prime, which has moved up 75 basis points from a year ago…We have observed a number of lenders increase rates to borrowers…We know that consumers are feeling the increase in rates.”

And that’s before the Fed rate hikes that are to come.

The bottom line is it likely means more debt and higher interest payments that lead to less disposable income for consumers to spend.

 

More US consumers getting squeezed

All of this points to an already stretched consumer base that has increasingly turned to debt given that real wage growth has been tepid at best over the past decade. And this doesn’t even touch on the degree to which the American consumer is under-saved or has little in the way of an emergency fund to cover those unforeseen expenses. Per Northwestern Mutual’s 2018 Planning & Progress Study, which surveyed 2,003 adults:

  • 78% of Americans say they’re ‘extremely’ or ‘somewhat’ concerned about not having enough money for retirement. Another 66 percent believe that they’ll outlive their retirement savings.
  • 21% of Americans have nothing at all saved for the future, and another 10 percent have less than $5,000 saved or invested for their golden years.

Adding credence to this figures, Bankrate’s latest financial security index survey, showed that 34% of American households experienced a major unexpected expense over the past year. But, only 39% of survey respondents said they would be able to cover a $1,000 setback using their savings. Other findings from Bankrate, based on data from the Federal Reserve, showed that those Americans between the ages of 55 and 64 that have retirement savings only have a median of $120,000 socked away. A similar 2016 GOBankingRates survey found that 69 percent of Americans had less than $1,000 in total savings and 34 percent had no savings at all.

Nearly 51 million households don’t earn enough to afford a monthly budget that includes housing, food, childcare, healthcare, transportation and a cell phone, according to a study by the United Way ALICE Project. That’s 43% of households in the United States.

As the New Middle Class in the emerging economies like China, India and parts of South America continue to expand, it will drive competitive world-wide pressures for food, water, energy and other scarce resources that will drive prices higher given prospects for global supply-demand imbalances.

 

Middle-Class Squeeze pain brings opportunity with Costco and others

What this tells us is that there is a meaningful population of Americans that are in debt and are not prepared for their financial future. In our experience, pain points make for good investment opportunities. In the case of the Middle-Class Squeeze investment theme, it means consumers trading down when and where possible or looking to stretch the disposable dollars they do have.

It’s no coincidence that we’re seeing a growing move toward private label brands, not only at the grocery store for packaged foods and beverages but by the likes of Amazon (AMZN) as well. We’re also seeing casual dining and fine dining restaurant categories give way to fast casual, and as one might expect the data continues to show more Americans eating at home than eating out.

From my perspective, the best-positioned company for the Middle-Class Squeeze investing theme is Costco Wholesale (COST). By its very nature, the company’s warehouse business model aims to give consumers more for their dollar as Costco continues to improve and expand its offering both in-store and online. To me, one of the smartest moves the company made was focusing not only on perishable food but on organic and natural products as well. That combination keeps customers coming back on a more frequent basis.

Let’s remember too, the secret sauce baked into Costco’s business model – membership fees, which are high-margin in nature, and are responsible for a significant portion of the company’s income. As I’ve shared before, that is a key differentiator compared to other brick & mortar retailers. And Costco looks to further expand that footprint as it opens some 17 more warehouse locations in the coming months.

I’ll continue to monitor Costco’s monthly sales reports, which have clearly shown it taking consumer wallet share, and juxtaposing them against the monthly Retail Sales report to confirm those wallet share gains.

  • As we recast our Rise & Fall of the Middle Class into two themes – the New Middle Class and the Middle-Class Squeeze, we are calling out Costco Wholesale (COST) shares as a top Middle-Class Squeeze pick, reiterating our Buy rating on the shares, and bumping our price target from $210 to $220.

 

Examples of companies riding the Middle-Class Squeeze Tailwind

  • Walmart (WMT)
  • Amazon (AMZN)
  • McDonald’s (MCD)
  • Dollar Tree (DLTR)
  • TJX Companies (TJX)
  • Ross Stores (ROST)
  • Kohl’s (KSS)

Examples of companies facing the Middle-Class Squeeze Headwind

  • Dillard’s (DDS)
  • JC Penney (JCP)
  • Macy’s (M)
  • Target (TGT)
  • Gap (GPS)
  • Red Robin (RRGB)

Again, those are short lists of EXAMPLES, not a full list of the companies benefitting or getting hit.

Over the next several weeks, I’ll be revisiting our investment themes, both the ones being tweaked as well as the ones, like Safety & Security, that are fine as is.

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

 

KEY POINTS FROM THIS WEEK’S ISSUE:

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List.
  • While the markets are reacting mainly in a “shoot first and ask questions later” nature, given the widening nature of the recent tariffs there are several safe havens that patient investors must consider.
  • We are recasting several of our Investment Themes to better reflect the changing winds.

 

Investor Reaction to All the Tariff Talk

Over the last two days, the domestic stock market has sold off some 16.7 points for the S&P 500, roughly 0.6%. That’s far less than the talking heads would suggest as they focus on the Dow Jones Industrial Average that has fallen more than 390 points since Friday’s close, roughly 1.6%. Those moves pushed the Dow into negative territory for 2018 and dragged the returns for the other major market indices lower. Those retreats in the major market indices are due to escalating tariff announcements, which are raising uncertainty in the markets and prompting investors to shoot first and ask questions later. We’ve seen this before, but we grant you the causing agent behind it this time is rather different.

What makes the current environment more challenging is not only the escalating and widening nature of the tariffs on more countries than just China, but also the impact they will have on supply chain part of the equation. So, the “pain” will be felt not just on the end product, but rather where a company sources its parts and components. That means the implications are wider spread than “just” steel and aluminum. One example is NXP Semiconductor (NXPI), whose chips are used in a variety of smartphone and other applications – the shares are down some 3.7% over the last two days.

With trade and tariffs being the words of the day, if not the week, we have seen investors bid up small-cap stocks, especially ones that are domestically focused. While the other major domestic stock market indices have fallen over the last few days, as we noted above, the small-cap, domestic-heavy Russell 2000 is actually up since last Friday’s close, rising roughly 8.5 points or 0.5% as of last night’s market close. Tracing that index back, as trade and tariff talk has grown over the last several weeks, it’s quietly become the best performing market index.

 

A Run-Down of the Select List Amid These Changing Trade Winds

On the Tematica Investing Select List, we have more than a few companies whose business models are heavily focused on the domestic market and should see some benefit from the added tailwinds the international trade and tariff talk is providing. These include:

  • Costco Wholesale (COST)
  • Dycom Industries (DY)
  • Habit Restaurants (HABT)
  • Farmland Partners (FPI)
  • LSI Industries (LYTS)
  • Paccar (PCAR)
  • United Parcel Services (UPS)

We’ve also seen our shares of McCormick & Co. (MKC) rise as the tariff back-and-forth has picked up. We attribute this to the inelastic nature of the McCormick’s products — people need to eat no matter what — and the company’s rising dividend policy, which helps make it a safe-haven port in a storm.

Based on the latest global economic data, it once again appears that the US is becoming the best market in the market. Based on the findings of the May NFIB Small Business Optimism Index, that looks to continue. Per the NFIB, that index increased in May to the second highest level in the NFIB survey’s 45-year history. Inside the report, the percentage of business owners reporting capital outlays rose to 62%, with 47% spending on new equipment, 24% acquiring vehicles, and 16% improving expanded facilities. Moreover, 30% plan capital outlays in the next few months, which also bodes well for our Rockwell Automation (ROK) shares.

Last night’s May reading for the American Trucking Association’s Truck Tonnage Index also supports this view. That May reading increased slightly from the previous month, but on a year over year basis, it was up 7.8%. A more robust figure for North American freight volumes was had with the May data for the Cass Freight Index, which reported an 11.9% year over year increase in shipments for the month. Given the report’s comment that “demand is exceeding capacity in most modes of transportation,” I’ll continue to keep shares of heavy and medium duty truck manufacturer Paccar (PCAR) on the select list.

The ones to watch

With all of that said, we do have several positions that we are closely monitoring amid the escalating trade and tariff landscape, including

  • Apple (AAPL),
  • Applied Materials (AMAT)
  • AXT Inc. (AXTI)
  • MGM Resorts (MGM)
  • Nokia (NOK)
  • Universal Display (OLED)

With Apple we have the growing services business and the eventual 5G upgrade cycle as well as the company’s capital return program that will help buoy the shares in the near-term. Reports that it will be spared from the tariffs are also helping. With Applied, China is looking to grow its in-country semi-cap capacity, which means semi- cap companies could see their businesses as a bargaining chip in the short-term. Longer- term, if China wants to grow that capacity it means an eventual pick up in business is likely in the cards. Other drivers such as 5G, Internet of Things, AR, VR, and more will spur incremental demand for chips as well. It’s pretty much a timing issue in our minds, and Applied’s increased dividend and buyback program will help shield the shares from the worst of it.

Both AXT and Nokia serve US-based companies, but also foreign ones, including ones in China given the global nature of smartphone component building blocks as well as mobile infrastructure equipment. Over the last few weeks, the case for 5G continues to strengthen, but if these tariffs go into effect and last, they could lead to a short-term disruption in their business models. Last week, Nokia announced a multi-year business services deal with Wipro (WIT) and alongside Nokia, Verizon (VZ) announced several 5G milestones with Verizon remaining committed to launching residential 5G in four markets during the back half of 2018. That follows the prior week’s news of a successful 5G test for Nokia with T-Mobile USA (TMUS) that paves the way for the commercial deployment of that network.

In those cases, I’ll continue to monitor the trade and tariff developments, and take action when are where necessary.

 

Pulling the plug on MGM shares

With MGM, however, I’m concerned about the potential impact to be had not only in Macau but also on China tourism to the US, which could hamper activity on the Las Vegas strip. While we’re down modestly in this Guilty Pleasure company, as the saying goes, better safe than sorry and that has us cutting MGM shares from the Select List.

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List

 

Sticking with the thematic program

On a somewhat positive note, as the market pulls back we will likely see well-positioned companies at better prices. Yes, we’ll have to navigate the tariffs and understand if and how a company may be impacted, but to us, it’s all part of identifying the right companies, with the right drivers at the right prices for the medium to long-term. That’s served us well thus far, and we’ll continue to follow the guiding light, our North Star, that is our thematic lens. It’s that lens that has led to returns like the following in the active Tematica Investing Select List.

  • Alphabet (GOOGL): 60%
  • Amazon (AMZN): 133%
  • Costco Wholesale (COST) : 30%
  • ETFMG Prime Cyber Security ETF (HACK): 34%
  • USA Technologies (USAT): 62%

Over the last several weeks, we’ve added several new positions – Farmland Partners (FPI), Dycom Industries (DY), Habit Restaurant (HABT) and AXT Inc. (AXTI) to the active select list as well as Universal Display (OLED) shares. As of last night’s, market close the first three are up nicely, but our OLED shares are once again under pressure amid rumor and speculation over the mix of upcoming iPhone models that will use organic light emitting diode displays. When I added the shares back to the Select List, it hinged not on the 2018 models but the ones for 2019. Let’s be patient and prepare to use incremental weakness to our long-term advantage.

 

Recasting Several of our investment themes

Inside Tematica, not only are we constantly examining data points as they relate to our investment themes we are also reviewing the investing themes that we have in place to make sure they are still relevant and relatable. As part of that exercise and when appropriate, we’ll also rename a theme.

Over the next several weeks, I’ll be sharing these repositions and renamings with you, and then providing a cheat sheet that will sum up all the changes. As I run through these I’ll also be calling out the best-positioned company as well as supplying some examples of the ones benefitting from the theme’s tailwinds and ones marching headlong into the headwinds.

First up, will be a recasting of our Rise & Fall of the Middle-Class theme.  As the current name suggests, there are two aspects of this theme — the “Rise” and the “Fall” part. It can be confusing to some, so we’re splitting it into two themes.  The “Rise” portion will be “The New Global Middle Class” and will reflect the rapidly expanding middle class markets particularly in Asia and South America. On the other hand, the “Fall” portion will be recast as “The Middle Class Squeeze” to reflect the shrinking middle class in the United States and the realities that poses to our consumer-driven economy.

We’ll have a detailed report to you in the coming days on the recasting of these two themes, how it impacts the current Select List as well as other companies we see as well-positioned given the tailwinds of each theme.