Robust Corporate Earnings Face Pressured Consumer, Tight Job Market

Diane (0:00)

Outside of the data center build out, our next guest says that much of the economy is stuck in the mud. For more, we want to welcome in Garrett Melson, portfolio strategist, the Texas Investment Manager Solutions. Garrett, it's good to see you. Haven't talked to you in a little while. So you described the economy as ho-hum, where at the beginning of another earning season cycle right now, we just got a slew of banks reporting. JPMorgan Chase, Goldman Sachs, you got Wells Fargo out, you've got Citigroup.

As earning season gets underway, what are you looking for under the hood to tell you whether some of the weak points of the economy that you're worried about? What are you looking for?

Garrett Melson (0:39)

Yeah. Well, thanks for having me back, Diane. I wouldn't say that we really have a negative or weak view of the outlook. It's more so that where we've seen nominal growth accelerate to 6.25 or 6.3 percent over the past year, our view is more in line that it's consistent with about maybe 4.5 to 5 percent growth, which is certainly not terrible. If you think about that as kind of the baseline for revenue growth and then a little bit of margin expansion on top of that, that is still a pretty decent backdrop for corporate earnings to continue pushing higher and booking pretty decent growth in here.

I wouldn't say it's a negative outlook in terms of this earning season. Obviously, this morning, we're getting a look from the banks, maybe a little bit of a miss on some of that FIC trading. But broadly, I think a lot of the commentary that you've heard so far is that conditions are still holding up pretty well, right? Consumers are still earning income, they're still spending, balance sheets are still very strong across households as well as corporates. So there's still a lot of strength in there. I just think it's more of a story of the marginal rate of growth. But as I said, as you look out to the rest of the earning season, you've continued to see those estimates grinding higher in pretty impressive fashion, very much in contrast to the typical fishhook shape that we see, where earnings estimates move lower into that earning season and then surprise the upside. The last couple of quarters, we've just seen upside revisions and then ultimately beats by corporate America. I think we'll likely see more of the same this quarter as well.

Diane (2:04)

So let me ask you a little bit more about the consumer. For instance, Wells Fargo, we know that's the biggest consumer-facing name in the group. They said that the consumer, to paraphrase, is still holding up their consumer banking lending division revenue there up 5% year over year. They've got growth there for about 14 consecutive quarters here.

You are expecting consumer spending to cool, if I understand correctly. What are you watching for on where you expect that slowdown to show up?

Garrett Melson (2:35)

Yeah, it's a moderation in the pace. So again, over the last year and even over the last quarter or so, we've seen really a pretty impressive bounce in real consumption. So running north of 3% for Q2.

You've seen some of that resilience hold pace in Q3 as well. But I think when you look at what generally drives consumer spending, it's nominal incomes. So if you take a look at nominal incomes or even real incomes, they've been sharply underpacing what we've seen in terms of the consumption backdrop. So yes, that suggests that you've seen a compression in the savings rate and we have. Ultimately, that tends to be somewhat of an unsustainable driver of consumption. So again, it's not raising alarm flags and ringing the alarm bells here, but it's more so of the view that we've probably seen the peak in terms of consumption for this year. And in our view, you're probably likely to see that moderate in real terms, probably closer to about 2 percent.

You've certainly seen some pressure from the discretionary space staples as well. So it's hard to kind of look at that complex and say that the consumer is doing very well. But when you look through a lot of the details, the consumer is doing just fine. But we do see that there are some signs that you're more likely to see a moderation in that pace to something still decent around 2 percent in real terms.

Diane (3:49)

Are you worried at all about the labor market or you're okay with that?

Garrett Melson (3:54)

Yeah, we were a little bit more cautious on the labor market entering this year. I think it's very clear you've seen a pretty impressive stabilization there. So conditions have gotten better, and I'd say conditions are largely stable.