Just how strong is the U.S. consumer? Here's what Wall Street has to say — and the stocks it likes

Published Tue, Aug 9 20228:19 PM EDT

The U.S. Federal Reserve has hiked interest rates by 225 basis points so far this year, with more potentially on the cards. One indicator that's likely to feature prominently in the Fed's thinking as it weighs the scale of further hikes is the strength of the consumer. It plays a pivotal role in the Fed's decision making, but the data paint a mixed — and sometimes confusing — picture. Indicators of consumer health Bank of America believes unemployment is the "most important" metric for determining the health of the consumer. In a Jul. 27 note, analyst Mihir Bhatia said that consumers will likely be able to fulfill their monthly card payments and loans so long as they remain employed. The U.S. added 528,000 new jobs in July as the unemployment rate fell to a pre-pandemic low of 3.5%, suggesting that the labor market remains on a strong footing. Wage growth also surged higher, as average hourly earnings jumped 0.5% for the month and 5.2% from the same period a year ago. Another closely watched indicator is consumer spending, which accounts for more than two-thirds of U.S. economic activity. Consumer spending increased more than expected in June, with the personal consumption expenditures price index jumping 1.0% from a month ago — its biggest monthly gain since Feb. 1981. 'A number of rising risks' But Wells Fargo warned that consumers are dipping into their savings to keep up their spending, as income fails to keep pace with prices rising at their fastest rate since the early 1980s. "We are concerned that the uncanny staying power of the consumer will soon run out," Well Fargo senior economist Tim Quinlan said on Jul. 29. In a note on Aug 2, Barclays analyst Terence Malone noted a slowdown in the pace of spending on goods and services in June, from both high-income and low-income consumers. He added that consumer sentiment is at a decade-level low, as measured by the University of Michigan consumer sentiment index — widely seen as a reliable barometer of consumers' confidence in the economy. Goldman Sachs also sees "a number of rising risks," as lower consumer confidence, eroding wealth and inflation impact consumers' willingness to keep spending by drawing on savings. Read more Wall Street banks like growth stocks again. Here are the top picks from Goldman and more This small-cap fund has outperformed the S & P 500 this year. Here are the stocks it owns BlackRock: The era of steady growth has ended, but here's how investors can prepare for it Meanwhile, the second-quarter earnings reports of several consumer names have further fueled the debate around the strength of the consumer. Bank of America noted that while the overall message from large pure-play card issuers such as American Express is one of continued strong consumer balance sheets, some consumer companies such as Walmart and Bath & Body Works have painted a picture of a pressured consumer and accordingly lowered their 2022 outlooks. How to position With many market watchers now warning of downside risks ahead, how should investors position in this environment? Barclays compiled a list of stocks that it thinks can thrive even as spending eases. The list includes Archer Daniels Midland , McDonald's , Coca-Cola , PepsiCo , fertilizer company Nutrien and online travel platform Expedia . Morgan Stanley said it is already seeing early signs of consumers trading down in purchases such as tobacco, grocery, and fast food. It expects this to "quickly extend" to other categories should inflationary pressures on consumer spending continue. Potential beneficiaries of such a shift would include discount retailers TJX and Ross Stores , beverage company Molson Coors Beverage , as well as fast food chains Yum! Brand and Domino's Pizza . Goldman Sachs sees several opportunities in defensive and high-quality discretionary names as it sees consumer spending improving next year. Its top picks include Target and Chipotle Mexican Grill .