With the 30-year mortgage rate in the United States approaching 8% and the United Kingdom’s mortgage rate at almost the exact same level, people are forking over a huge share of their take-home pay for housing. Paychecks have not kept up with this trend, or with sharply rising consumer prices, and consumer spending is falling as a result. During the most recent earnings season, this has become apparent everywhere.
Consumer Wallets Are Tightening
Target TGT reported falling sales for everything from food to clothing to toys. Consumer staples firms such as Kraft Heinz KHC, Unilever UL, and Nestle NSRGY, which many believed resistant to such cutbacks, have also experienced volume declines. Even beer, the holy grail of this category, has seen sales volumes fall, as reported by Anheuser-Busch InBev BUD and Heineken, the world’s largest brewing firms.
During the past year, we have been highlighting luxury goods as a safe haven in this space. But even here, growth has started to slow. Beauty products manufacturer Estee Lauder Companies EL reported a softening in sales of skincare products, while Hugo Boss saw declines in apparel. It seems even discerning consumers are becoming more selective the longer their wallets are squeezed.
Defense Stocks Remain Hot
Geopolitical risks are heating up. With uncertainty from the ongoing conflict in Ukraine and the flaring of tensions between Armenia and Azerbaijan now turbocharged by the war in Israel, it’s no wonder that so many investors are seeking exposure to aerospace and defense stocks.
It’s been a solid earnings season for weapons makers, and while orders can be lumpy—countries don’t order tanks the way people get shaving cream—the structural tailwinds are there. We now anticipate that this growth will remain uninterrupted for at least several years, considering that many countries, particularly in Europe, have underspent since the end of the Cold War.
Firms like France’s Thales are in a sweet spot, given significant stakes in a broad array of major international defense projects. Thales derives more than two-thirds of its defense revenues from Europe, where we expect military budgets to rise by more than a third over the next five years.
Home Builders Are Feeling the Pain
We’ve mentioned the effect of rising mortgage rates on consumer spending, but the more obvious impact is on housing itself. When the costs of borrowing get this high, households postpone plans to move and would-be first-time buyers remain in the rental market for longer.
Home builders are already taking a hit. We expect new projects at D.R. Horton DHI, the largest home builder in the U.S., to fall by 10% in 2023. Persimmon, one of the most prominent U.K. home builders, has seen its stock fall by almost two-thirds since April 2021.
The pain of unaffordable housing doesn’t stop there. The decline in new building projects is hurting industrial firms like Caterpillar CAT. Building materials firms are also taking a hit, with large suppliers Saint Gobain, Holcim, and Heidelberg Materials all reporting decreased volumes in the third quarter. So far, many of these companies have been able to largely offset this by pushing through price increases, but this cannot go on forever.
Some Firms Are Calling the Bottom on Industrial Orders
Manufacturing purchasing manager indexes are a key insight into the health of the industrial sector. A quick glance at the chart below will tell you that the readings haven’t been pretty. Any number under 50 means we’re in contraction territory. It’s been a while since the sector has experienced growth.
As consumer demand for almost all goods has fallen, that’s led to industrial firms producing less, and therefore spending less on machinery and raw ingredients or precursor materials. Another issue is de-stocking. Right after the supply disruptions of the COVID-19 pandemic and the surge in consumer spending, most firms eagerly filled their inventories. In 2023, firms have been unwinding these large stockpiles, which has hastened the fall in demand for industrial products.
One bright spot from this earnings season has been chemical giants like DuPont DD and BASF potentially calling the bottom of the destocking trend, raising hopes for better earnings over the coming few quarters.
Banking Profitability May Have Hit Its Peak
It’s hard to believe a banking crisis took place just eight months ago. Since then, we’ve been through a cycle of earnings seasons. At first, we were focused on whether banks would survive at all. As the year has progressed and banking stocks steadily regained lost ground, the emphasis has moved to profitability.
For a decade after the global financial crisis, this wasn’t a great sector to be in. Higher capital ratios imposed by central banks meant the banking model became less profitable. On top of this, historically low interest rates and a relatively subdued economy crimped banks’ ability to make money. The recent surge in interest rates may mean that net interest margins (the difference between what banks borrow and lend at) will again widen.
For banks, this has brought soaring profitability, which shone through in earnings this quarter. Our concern is that things might be heading downhill from here. With mortgage applications falling rapidly and loan losses set to increase as consumers and businesses struggle to make high interest payments, bank profitability may come under pressure once again.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.