The low end consumer is still struggling

Good morning. Dollar Tree was Unhedged's top stock pick for 2024, up about 14 percent. But it brought it all back yesterday, when it announced it would close 1,000 of its 16,000 stores and take charges. We knew that closing stores was a risk, and that the decision to downsize for growth seemed smart, but knowing when a restructuring plan would pay off was difficult. Stock picking is difficult. Send me your exhausted stories: robert.armstrong@ft.com.

Reconsider the bad part of economics

Well, this doesn't look great:

We talked fairly constantly [about how] It's a challenging consumer environment. Consumers work through… . . All the inflation that hits their pockets. . . Higher interest rates have an impact. I think particularly for low-income consumers, you have two additional dynamics, which has eroded the Covid savings that people were relying on and spending has largely disappeared. . . You're starting to see that price inflation for eating at home versus dining out is due to its historical dynamic, which means some of these consumers are choosing to eat at home more often.

. . .[in]In the casual dining out segment, it is certainly likely that this year we will see negative traffic. . . From an industry perspective because of those dynamics

This is Ian Borden, McDonald's CFO, speaking at an industry conference yesterday. This kind of talk may seem at odds with the agreed-upon narrative about economics. Growth and employment remain strong, so strong in fact, that expectations of Fed rate cuts in the future have been pushed further. Although inflation refuses to reach the target target, it has come down a lot.

Borden's comments came as enough of a surprise that McDonald's shares fell nearly 4 percent on the day. But the shock should not be too great. There have been signs for a year or more that consumers at the lower end of the income scale are not fully participating in the boom (we've written about these signs, for example, here and here ). What is noteworthy is that these bleak signs have persisted even as public fear about a recession has faded in the past few months.

The dichotomy between the booming economy and the pressures on low-income consumers is shown in the New York Fed's chart of auto loan delinquency rates, broken down by age:

Borrowers under age 40, who are more likely to have high debt relative to assets, are falling into delinquency at rates slightly lower than those seen at the height of the Great Financial Crisis. At that time, unemployment was 10 percent; Now it's less than four. This is still an extraordinary economy. If anything, given what we see in the delinquency data, it's surprising that more companies aren't making comments like Borden's.

I must stress that I am not saying this in a way that the good news is fake and that we are doomed. As Apollo's Torsten Slok told me, most of the purchasing power in the economy is toward the upper end of the income spectrum, and these households have a lot of money on hand. There is a difference between unbalanced growth and unsustainable growth. His plan:

Companies that cater to the low-end consumer have already felt some pressure. Consumer staples stocks, as we wrote, have moved sideways since May of last year and have lagged the market by more than 20 percent. This is partly because commodities outperformed in 2022 and the market had to play catch-up. Partly because many underlying stocks are alternatives to bonds, which are losing popularity as bond yields rise; This is partly because defensive stocks tend to underperform in risk-on spikes. But these factors are not the whole story. Consumer declines will remain under pressure, especially if interest rates remain high for longer because the broader economy remains hot. It would be surprising if Borden's comments are not replicated by other companies exposed to the low-cost consumer in the coming months.

Why JPMorgan is so dominant, Part 3: Growth in context

Over the past couple of days we've talked about JPMorgan's dominant position in banking, how its diversified financial structure has helped it grow, and how the bank has been part of a broader trend of increasing returns in banking. We have raised the question of how best to explain rising returns in the banking sector in general, and JPM's rise to dominance in particular. But before answering that last question, I thought it might be a good idea to be a bit more precise about the long-term growth rate of this industry, the largest banks, and JPM.

To do this, I looked at two time slices of FDIC data, from early 2003 and late 2023, using BankRegData's data collection tool. The first point to note is that the increase in industry concentration over the past 20 years, as measured by assets, has been significant. At the time, Citibank was the largest bank, holding 8 percent of assets in the system; Now it's the party of JP Morgan, at 14 percent. There was a general movement of assets towards the major banks:

Over 20 years, assets in the US banking system grew by 5 percent annually. The big six banks performed even better – with the exception of the exceptional Citi:

JPM, Bank of America, Wells, and U.S. Bank all outgrew the banking system despite being in the top 10 by volume in 2003 as well (BNC was 22nd at the time). The growth winds behind the big banks in the US are very clear.

PNC, with its really impressive growth, makes for an interesting comparison with JPM. Although it is the sixth largest bank in the United States, it has only one-sixth of the assets of JPMorgan. It is still essentially a regional bank, albeit a large one. However, for most of the past two decades, PNC shares kept pace with JPM shares — until interest rates started to rise in 2022, and other regional banks started to struggle:

Safely doubling asset growth while achieving a competitive return on equity is what makes bank stocks soar. The recent suffering of shares in PNC, a bank that has done just that over a long period compared to JPM, suggests that the advantages of scale in banking have become stronger in the past few years.

However, the key question remains: What, other than a favorable corporate structure, has allowed JPMorgan to double growth at an even faster rate than its larger peers?

One good read

Cat Bond Math.

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