Standard Life Investments

Focused Insight

Wall Street versus Main Street

  • Is this the year of the reverse wealth effect for US consumers?
  • Where are we finding opportunities in the US retail sector?
  • Which companies are the beneficiaries of moderate-income consumers?

Year of the underdog

With mixed data signals coming out of the US and investors concerned by recent volatility, it becomes increasingly important to look beyond macroeconomic headlines and find grass roots opportunities. One question we have been asking is could 2016 be the year of the reverse wealth effect for US consumers? With concerns over a slowing economy, the high-income consumer is starting to watch their wallet. While luxury spending is therefore starting to come under pressure, more moderate-income consumers are bucking this trend and appear less concerned about the health of the economy.

A sweeping move by Obama’s administration was to strengthen the middle class and help those with slow-growing incomes. This resulted in many states boosting the minimum wage and new rules that should increase the number of workers eligible for overtime. At the same time, jobs growth in lower-paid industries, such as restaurants and retail, helped to increase the number of moderate-income employees and consequently consumers. These consumers are more inclined to spend a high level of their disposal income, beneficial for companies already targeting the lower-end consumer.

Bargain hunting

Dollar Tree, a discount store where merchandise has a fixed $1 price tag, has gone from strength to strength. Having acquired its rival Family Dollar, it has created synergies, improved overheads and raised yearly guidance. The theory that consumers are more likely to spend permanent income compared to transitory income, such as wage increases rather than energy savings, should prove to be a tailwind for Dollar Tree. With further synergy targets and minimum wage increases benefiting low-wage workers, the potential for growth appears more robust compared to many higher-end competitors.

Although wage increases are advantageous for employees, this can create headwinds for employers, particularly those where margins may be smaller and scale important. This has not proved to be a concern for ‘off-price’ retailer TJX Companies. Operating as T.K. Maxx in Europe, the company has expanded its retail operations, and grown global sales despite US dollar strength.

TJX’s ‘treasure hunt’ offering - if consumers search hard enough they can find good deals on desirable products - appeals to moderate-income consumers, particularly as their spending power increases as a result of wage changes. In that respect, TJX has been successful in continuing to grow the number of brands and products it offers and to keep customers coming back. This is particularly important at a time when other higher end retailers are experiencing a slowdown. TJX’s success is also due to its increasing purchasing power. This has helped drive down unit costs for consumers at the same time as growing its own margins. Further margin expansion can potentially come from improved supply chain logistics, releasing brands from excess inventory and getting the right goods to the right stores in a timely fashion. Recent growth in Europe is also likely to provide a tailwind for the company.

Dollar Tree and TJX prove that as many consumers become more reticent, pockets of growth still exist. The key for investors is recognising where some companies are challenging headline trends and, in this instance, where Wall Street is not necessarily representative of Main Street.