The economy is characterized by an array of conflicting data and economic signals. Corporate profits remain strong, consumer spending is grinding higher, and the unemployment rate sits at historically low levels. However, the cumulative effects of inflation have placed severe financial pressures on U.S. households, particularly lower-income families, leading to record credit card debt and declining consumer sentiment. With additional unknowns on the horizon – such as an upcoming presidential election, the rapid adoption of AI, and the Fed’s decision on interest rates – analysts and investors are facing greater difficulty than ever when it comes to forecasting the health of the economy.
This is made even more challenging when looking at the consumer space, including the consumer hardlines subsector – a $3 trillion sector that encompasses durable goods ranging from appliances, to tools, to electronics. While hardlines spans multiple categories, its greatest application lies in the housing market, where its products are crucial for both new construction and existing home upgrades.
Sluggish sales activity from key firms, along with certain negative economic indicators, have led some analysts to question the financial health of the industry. However, a closer look at consumer hardlines through our team's holistic lens – covering both traditional retail and emerging digital platforms – reveals a more nuanced picture.
Despite cracks emerging in the economy, the reality is that consumers, particularly those in middle- and upper-income tiers, have been able to weather the storm and stay financially stable. Furthermore, although spending patterns have shifted from goods to services in recent years, this could reverse as pent-up demand for household formation spurs a flurry of new buying activity.
Additionally, several upcoming potential catalysts – ranging from the potential for lower interest rates to aging housing stock to untapped home equity – have the capacity to boost housing turnover and home repairs, and subsequent furniture / furnishings, transforming the current lukewarm sector into an eventual booming market.
A Largely Favorable Macroeconomic Climate
The last few years have left many consumers with declining purchasing power, an increased cost of living, and dwindling economic confidence – yet Americans have continued to spend. Data from the US Census Bureau indicates that seasonally adjusted retail sales through the first several months of the year have tracked up about +3% year-over year. This follows gains of +4-5% in the back half of 2023.
In short, consumers are still largely financially healthy and fighting through inflation relatively well, with the overall pace of sales growth still respectable. This raises an important question: how have U.S. households continued to show resilience in the face of such strong economic headwinds? The answer lies in the two foundations supporting the current economy – healthy employment and real wage growth.
With the unemployment rate hovering at or below 4% for nearly two years, tighter labor markets are placing upward pressure on wages. This has led many companies to push through pay increases to remain competitive. These conditions are expected to continue in the foreseeable future, leaving consumers with more opportunities to generate income and greater compensation for doing so.
However, the current economic climate has not benefited every consumer firm. Recent reports from companies including Home Depot, Lowe’s, AutoZone, CarMax, and Five Below indicate more volatile spending patterns, which align with overall sluggish GDP growth for the first quarter. Lower-end consumers, in particular, appear to be struggling, resulting in deferred purchases in key categories such as auto parts.
While positive trends may normalize as the year progresses and into 2025, the road to recovery appears bumpy, underscoring the nuanced and uneven nature of a consumer spending rebound and concerns of a slowing consumer and trade down activity.
Future Catalysts
In the current economy, homeowners stand out as one of the better-positioned segments among consumers. With a limited supply of new homes in major U.S. markets, housing prices have steadily risen over the past decade, and are expected to continue to gain in value over the coming years. According to data from Intercontinental Exchange, homeowners now sit on a combined $16.9 trillion of home equity – an all-time high.
But these rising prices, and the confidence that comes with it, have not yet translated into a surge in home repairs or remodeling. Comparable sales for larger ticket transactions – which usually have some aspect of financing - contracted by (6.5%) in Q1 for Home Depot compared to a (6.9%) drop in Q4. These projects typically involve major renovations and include bathroom or kitchen remodels that can add up to $20K or more.
Despite large reserves of home equity, households continue to defer more extensive remodeling work amid higher interest rates, dragging down the larger industry. This has led to a significant amount of pent-up demand, with a large amount of equity sitting on the sidelines waiting to be unleashed.
What catalysts could unlock this pent-up demand? The Fed’s decision and timing on lowering interest rates will have the greatest impact to the pent-up consumer demand. From the perspective of a homebuyer, nothing ignites consumer spending more within the industry than a home purchase and the multitude of additional expenditures that come with it, such as painting, flooring, appliances, seasonal categories, etc.
Currently, 53% of US homes are over 40 years in age, indicating a rapidly aging and deteriorating housing stock. With higher housing prices boosting homeowner confidence, any decline in the price of loans should support a prolonged stretch of renovation and remodel activity.
This upswing in home sales and remodeling has the potential to significantly benefit consumer hardlines firms. Lowe’s, for example, generates around 75% of revenue from Do-It-Yourself (DIY) projects, a category that should potentially first see an upswing with housing turnover and later lead to better trends on the pro side with increased remodeling activity.
Goods vs Services
It’s no secret that Americans’ spending patterns are changing. Younger Americans are now more likely to purchase items online, less likely to own a home, and tend to prefer spending on experiences rather than physical objects.
While industries such as travel, dining, and entertainment have benefited, goods now underperform services when it comes to consumer spending. The positive news is that while spending on consumer durables has declined in recent years, spendings remains well above pre-2020 levels without any indications of a sharp snap back on the horizon. Consumers can rest assured that this spending reversal is not due to consumer durables weakness, but from a faster than normal acceleration in services spending.
As the Millennial and Gen Z generations age, these groups may also make lifestyle changes that involve buying a home or starting a family. With many Millennials now reaching their peak spending years between 25 and 35, the potential exists for a spending shift back to physical goods as household formation increases.
This spending shift may not come in the form of traditional, in-store purchases. With online-initiated revenues continuing to grow and eat into sales at physical retail, the consumer internet subsector – which includes eCommerce sites and direct-to-consumer brands – will likely see a growing share of overall spending.
Take Wayfair as an example. The firm – which is now integrating AI into the customer experience – has grown to more than twenty million active customers through a solely digital presence. As housing-related headwinds ease and the consumers’ affinity for digital purchases migrates upwards, the company could see sustainable positive order growth and an improving margin profile.
Overall, the current consumer landscape remains defined by several crosscurrents – but coverage of both traditional store-based operators and emerging digital players points to ample opportunities for more agile, connected retailers to continue accumulating market share. With consumers still exhibiting spending resilience to date, homeowners sitting on a mountain of equity, and very early signs of rebalancing between goods and services, navigating the connected consumer will be critical.
Visibility remains limited and the timing of any inflection remains uncertain. Some green shoots have emerged, although any re-acceleration appears to be playing out more uneven and gradual than most investors had anticipated. Ultimately, the longer-term outlook for the sector remains constructive, and despite growing uncertainties around spending trends, opportunities across the consumer complex continue to emerge.