Why BofA is bullish on U.S. consumers despite inflation and interest-rate worries

By Christine Idzelis

As stocks climb this year, BofA says the death of the U.S. consumer has been 'greatly exaggerated'

Consumers still look resilient amid the current bull market for U.S. stocks, despite worries to the contrary due to the Federal Reserve's monetary tightening, according to BofA Global Research.

The death of the U.S. consumer has been "greatly exaggerated," said BofA equity and quantitative strategists led by Savita Subramanian, in a note on Monday. "Consumption has remained resilient" despite inflation and the ensuing rise in interest rates, they said.

Investors on Thursday will get an update on the health of the consumer via a Census Bureau report on U.S. retail sales in February. Retail sales fell more than expected in January.

"Overall, we still see more reasons to be bullish than bearish on the U.S. consumer," the BofA strategists said. "Trends in consumption have slowed but defied expectations of collapse from rising borrowing costs and inflation."

Consumer balance sheets remain "strong" after unprecedented fiscal stimulus during the COVID-19 pandemic, and as U.S. homeowners continue to benefit from having locked in fixed-rate mortgages before borrowing costs jumped, the strategists found.

While ratios of consumer health based on debt service and financial obligations are up since the Fed began raising rates in early 2022 to battle inflation in its fastest monetary-tightening cycle ever, they remain below levels seen before COVID, according to the BofA note.

The Fed's rate-hiking cycle has left many U.S. homeowners earning higher rates of return from their cash holdings than the effective rate of mortgages, according to the BofA note.

Around 90% of mortgage loans in the U.S. have fixed rates, according to the strategists. As a result, the effective mortgage rate is below pre-COVID levels at just 3.8%, despite the Fed's tightening cycle driving current mortgage rates much higher than that, their note said.

The Fed, whose benchmark rate currently stands at a target range of 5.25% to 5.5%, will later this month hold a two-day policy meeting concluding March 20.

Meanwhile, "demographics and early retirement during COVID have kept the labor market tight, and real wage growth (a strong driver of consumption) inflected to positive territory in mid-2023," according to the strategists.

'Gentle slope'

"While consumption trends have started to slow, we expect the U.S. consumer to remain healthy in 2024," the BofA strategists said. "Investors worry that spending stops when excess savings run out, but the rundown is more likely to be a gentle slope than a cliff edge."

U.S. stocks were trading mostly lower on Monday, ahead of a highly anticipated reading on inflation on Tuesday. The Dow Jones Industrial Average DJIA was up 0.1% in afternoon trading, while the S&P 500 SPX fell 0.1% and the Nasdaq Composite COMP shed 0.3%, according to FactSet data, at last check.

See: Stock market's 2024 bull run faces looming inflation report

BofA's equity and quant strategists recently raised their year-end target for the S&P 500 to 5,400 points. The S&P 500 was trading around 5,117 on Monday afternoon, according to FactSet data, at last check.

When it comes to stock picking, "consumer sectors have always had more idiosyncratic risk than others," the BofA strategists said in their note on Monday. They remain "overweight" on the consumer-discretionary sector and "underweight" on consumer staples.

Their preference for consumer-discretionary stocks is due to consumer resilience, as well as BofA economists' forecast for a "soft landing" for the U.S. economy and an expected shift by the Fed toward easing its policy.

See: Bullard says February job report increases chance of Fed cutting interest rates sooner

"Consumer discretionary trades at a premium to historical valuation measures, whereas consumer staples trades at a discount," the BofA strategists said. "But consumer-discretionary multiples look more reasonable" excluding megacap companies Amazon.com Inc. (AMZN) and Tesla Inc. (TSLA), they added.

As for performance, the S&P 500's consumer-discretionary sector has climbed around 2% so far this year, lagging consumer staples and the broader U.S. equities index based on Monday afternoon trading levels.

The capitalization-weighted S&P 500 has climbed more than 7% this year, while its consumer-staples sector has advanced around 5%, according to FactSet data, at last check.

But on an equal-weighted basis, the S&P 500's consumer-discretionary sector is outperforming staples so far in 2024.

Shares of the Invesco S&P 500 Equal Weight Consumer Discretionary ETF RSPD have gained 4.2% this year as of Monday afternoon, while the Invesco S&P 500 Equal Weight Consumer Staples ETF RSPS has risen 3.1%, FactSet data show, at last check.

Meanwhile, the S&P 500 ended Friday less than 1% below the index's all-time closing peak on March 7, according to Dow Jones Market Data.

"This bull market has legs," BofA said in a quant-strategy note on Friday. "Bull markets end with euphoria, and today euphoria has been ring-fenced to themes" such as artificial intelligence.

-Christine Idzelis

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03-11-24 1434ET

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