A resilient consumer has helped stave off a recession so far, but that may not last.
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Bearish sentiment has been subdued this year as the consumer and economy stay strong. Much of the bullish optimism towards a soft-landing scenario in the economy hinges on this continued resilience.These are the five most pressing questions investors should be asking about the sustainability of such resilience.
The decline in bearish sentiment over the past year has been driven by a surprisingly resilient consumer, which has helped prop up the economy to avoid a recession.
But as sentiment towards the economy shifts from bearish to bullish and a potential soft-landing-no-recession scenario, there are lingering questions as to whether the resilience of the all-important consumer can continue.
Bank of America’s Savita Subramanian highlighted in a Friday note the five most pressing questions investors should be asking about such resilience and its ultimate impact on the stock market and economy.
1. Can consumer resilience last with rates this high?
“US consumers have structural and cyclical advantages: 85% of US mortgages are fixed, low labor participation and tight immigration spell negotiating power, savings rates have increased since 2008, and real wage growth just inflected positive. Jobs are the lynchpin of confidence, and layoffs so far have been ringfenced to Silicon Valley and Wall Street. Absent broad-based job loss, consumption should remain healthy. Where we are seeing pockets of weakness are in the higher income cohort, the so-called ‘rich-cession,” Subramanian said.
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2. What’s the impact of tighter lending standards today?
“Less bad for S&P 500 earnings. Lending channels, credit uses and borrowers have been different since 2008 versus prior cycles. More credit came from regionals and shadow lending than large banks. Cyclical companies paid down debt vs. borrowing to expand capacity. The link between easy credit and better earnings has weakened since 2008, and formerly credit-sensitive sectors (Retail, Financials, Tech) now exhibit minimal sensitivity. Risks exist in genuinely impaired assets, but size is known and manageable,” Subramanian said.
3. Is the VIX too low? Doesn’t this smack of complacency?
“This summer, the VIX reached new post-COVID lows, and buy-the-dip behaviour has returned with a vengeance. But the VIX has been lower ~20% of the time, and the VIX is not a mean reverting measure – spikes can be followed by years of low volatility like we saw in the mid 90s and from 2005 to 2008,” Subramanian said.
4. What else could break?
“So far, regional banks, commercial real estate and US sovereign debt have frayed. Cracks will likely emerge elsewhere, we are watching hyper growth investments funded in later years of zero interest rate policy where hurdle rates for profitability today are significantly higher, ‘zombie’ companies burning through cash that may not survive the current rates backdrop – note that one-third of Russell 2000 companies don’t make money; illiquid assets that will eventually be marked down unless rates fall; companies forced to refinance at higher rates, and labor squeezes at companies where automation is non-viable.” Subramanian said.
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5. What looks better, US equities or rest of the world?
“US looks best across developed markets, but it may be time to add some emerging markets. US stocks have led rest of world since 2008 by 200%+ but US earnings handily beat other regions. Developed markets ex-US has lagged US by 2-3% per year for more than a century. US structural advantages include Tech primacy; reserve currency status; 5ppt+ latitude of Fed easing potential; reigned in inflation, and healthy balance sheets. US stocks are unloved vs. bonds, suggesting upside risks,” Subramanian said.
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