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Amazon (AMZN) founder and billionaire businessman Jeff Bezos recently issued a dire prediction:
If you’re an individual and you’re thinking about buying a large-screen TV, maybe slow that down, keep that cash, see what happens. Same thing with a refrigerator, a new car, whatever. Just take some risk off the table… If we’re not in a recession right now, we’re likely to be in one very soon.
His bearish view of the economy certainly jives with AMZN’s recent behavior, including confirming its plans to lay off some of its staff amid broader job cuts that could reach 10,000 at the company as it tries to improve efficiencies ahead of an economic downturn.
This follows a bearish tweet from Mr. Bezos a few weeks ago when he signaled agreement with Goldman Sachs (GS) CEO David Solomon that there is a good chance of recession in 2022-2023:
Yep, the probabilities in this economy tell you to batten down the hatches.
In this article, we will look at the outlook for U.S. consumer spending, the health of the American consumer, and why Mr. Bezos’ dire warning ultimately does not impact our outlook for the S&P 500 (NYSEARCA:SPY) or our investing approach moving forward.
U.S. Consumer Spending Checkup
Despite Mr. Bezos’ gloomy outlook and cautionary advice to consumers, based on the National Retail Federation’s projections, holiday sales are likely headed for a record high this year. The expectation is that they will come in between $942.6 billion and $960.4 billion this year, up by 7% at the midpoint from last year’s then-record of $889.3 billion.
While some credit this significant year-over-year projected increase as simply being due to price hikes to compensate for inflation, the reality appears to be different.
First of all, inflation has already taken its toll on the American consumer, so they have less capacity to spend this year. This is evidenced in the fact that American credit card balances have risen to a whopping $930 billion at the highest rate seen in 20 years. On top of that, credit card interest rates are rising along with broader interest rate trends across the U.S. economy. As a result, U.S consumer spending power is drying up rapidly. As a result, if anything, inflation should be providing a headwind to consumer spending this year.
On top of that, retailer inventories are flush this year, in contrast to last year when supplies were limited. As a result, it is widely expected that there will be a significant increase in holiday promotions, leading to significant discounts. For example, there is an expectation that computer prices could be slashed by up to 32% this year, compared with just 10% discounts last year. Toy discounts should reach 22%, up from 19%, while consumer electronics could be discounted up to 27% from 8% last year. As a result, any price increases from inflation will largely be offset from promotions.
As a result, despite Mr. Bezos’ caution to consumers and gloomy prediction for the economy, it appears that consumers are projected to spend at a record-setting pace this year.
SPY Implications
What does this mean for SPY? Well, it means that – at least for the foreseeable future – the American consumer remains confident enough to continue spending aggressively, and this strong consumer push through the holiday season should bolster the retail sector significantly. As inventories get cleared out, it will help retail businesses and related businesses (i.e., landlords, manufacturers, shippers, etc.) right-size their balance sheets and also set them up for improved supply-demand dynamics in 2023 and beyond. As a result, their finances should be healthier in 2023 and should also be able to sustain their payrolls better. For the first time since the COVID-19 lockdowns, the supply chains should finally be brought into balance.
That said, while the strong holiday spending should give the economy a shot in the arm in the short term, if a recession still hits the economy in full force with layoffs rising in 2023 in conjunction with elevated credit card debt, things could get ugly. On top of that, if the Federal Reserve continues to raise interest rates, problems could be compounded even further, as layoffs in combination with rising interest rates on credit card debt could lead to a spike in bankruptcies, which in turn could lead to massive losses for lenders, a rapid decline in consumer spending, and a spike in even mortgage defaults if things get bad enough.
Ultimately, it will come down to where inflation heads and what the Federal Reserve decides to do. If inflation has truly peaked – which recent evidence seems to suggest it has and is even declining – then the Fed should be able to pivot next year and perhaps rescue the economy from a deep recession. If, however, inflation is going to continue raging at exceedingly high levels, then the Federal Reserve will have to continue hiking interest rates and this holiday season’s aggressive credit-fueled spending spree will come back to bite many consumers and make the recession even worse.
However, we believe that the first scenario is most likely and therefore – while we still expect a recession – we think the Federal Reserve will pivot away from aggressive interest rate hikes next year, thereby mitigating some of the potential damage from this holiday season’s expected record-setting spending. As a result, Mr. Bezos’ gloomy outlook for the economy is not as important to us as is the future direction of the Federal Reserve’s interest rate decisions, as we think this will be far more influential on the future welfare of the American consumer than the current trajectory of the economy.
Our Outlook
With that said, the SPY remains slightly overvalued based on data from the models used at Current Market Valuation, so our view on it remains somewhat guarded. Based on the Yield Curve Model, the SPY looks strongly overvalued given that the 3-month Treasury Yields are higher than the 10-year Treasury Yields at present. According to the Buffett Indicator, SPY appears to be fairly valued as the ratio of total U.S. stock market value versus the most current measure of total GDP is within a reasonable range of the historical trend. The Price to Earnings model implies that SPY is overvalued given that the current Cyclically Adjusted PE ratio is 28.9, 43% above the historical trend of 20.1. The interest rate model implies that SPY is fairly valued given that it is only 0.9 standard deviations above the historical trend that compares the S&P 500 relative to interest rates. The S&P 500 mean reversion model implies that SPY is fairly valued given that it is within a reasonable distance from its historical trendline.
Last, but not least, the margin debt model implies that the stock market could be undervalued given that the total U.S. margin debt was down by $313 billion year-over-year and is 1.3 standard deviations below the historical trend. What this means is that people are not overextending themselves in the market and that market downturns may not be quite as sharp as in the past given that there will be fewer margin calls.
Investor Takeaway
While the fundamentals and valuation models prompt us to rate SPY a Hold at the moment, we believe that if the Federal Reserve is able to pivot next year due to falling inflation, the stock market should be just fine, even if the economy does fall into a shallow recession in 2023.
Regardless, however, our approach at High Yield Investor remains the same. While we are still building and holding a diversified portfolio of undervalued, quality, high yielding securities, we are especially targeting undervalued high yielding stocks at the moment that combine defensive, stable cash flows with inflation resistant business models. We believe that, for the foreseeable future, underwhelming returns from SPY combined with high levels of market volatility and growing bifurcations in performance across sector lines will make stock picking potentially much more rewarding than indexing. As a result, we rate SPY a Hold and are focusing our attention on opportunities in individual high yielding securities.
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