Goldman Sachs Shifts Focus to Middle-Income Consumers Amid Market Woes
Two months ago, Goldman's Prime Brokerage desk observed hedge funds quietly liquidating their consumer exposure prompting the bank to ask if something changed Following notable blow-ups in the consumer discretionary space the answer was yes because the XLY consumer discretionary ETF is flat on the year underperforming the broader S&P which continues to rise and is now up around 15% thanks to just five stocks
A month ago Goldman's previously bullish consumer specialist Scott Feiler wrote a follow-up note titled Glass Half Empty Investors grew concerned that strong spending growth might hide substantial weakness especially since companies during Q1 earnings calls increasingly highlighted a weaker lower-end consumer Mentions of low-income consumers reached record levels comparable to the post-COVID crash period
Goldman warned that higher rates and prices forced lower-income consumers to make tough trade-offs possibly leading to reduced spending This view was confirmed by poor retail sales reports for April and May and a slowing labor market influenced by illegal immigration and part-time work
With skepticism about the US consumer sector growing Goldman proposed shorting stocks with high exposure to low-income consumers a strategy that proved successful over the past month
Today Goldman raised its year-end S&P 500 target to 5600 mainly based on just five companies The bank increased its consumer sector skepticism and now targets middle-income consumers a month after focusing on low-income consumers
Goldman's thematic trading group led by Louis Miller indicated that US growth is viewed too optimistically and warned of issues with middle-income consumers Miller highlighted concerns about consumers trading down weaker company commentaries a disappointing April retail sales report and signs of a slowing labor market
Miller now suggests shorting Goldman's Middle Income Consumer basket GSXUMIDC which focuses on stocks with high exposure to middle-income consumers who may start trading down This basket is essential to the US economy as consumer spending accounts for 70% of GDP growth and can trade up to $300 million in one day
Goldman outlined three bearish economic factors for traders including increased tax withholdings and capital gains tax payments lowering discretionary spending tax refunds decreasing in real terms and unexpected inflation in Q1 negatively impacting real income and spending growth likely reducing consumer sentiment
Kate McShane Goldman's head of consumer retail noted that middle-income consumers are under the most financial pressure with the lowest projected discretionary cash inflow growth of 1.6% due to higher financial obligations and fewer mortgage equity withdrawals
Recent earnings reports from major consumer companies reflected these concerns McDonald's missed EPS estimates as consumers became more cautious with their spending 3M expects retail discretionary spending to remain subdued for the year Coca-Cola is seeing lower-income consumers opting for cheaper alternatives
Additionally Goldman's Middle Income Consumer basket GSXUMIDC has a debt profile similar to its High Yield Debt-Sensitive basket GSXUDEBT rather than a diversified consumer discretionary sector basket making this segment of the consumer sector vulnerable to both slowing revenues and higher interest expenses
Reflecting on past events there are echoes of 2007 when Goldman gave optimistic economic forecasts while advising top hedge fund clients to bet against the market This raises the question whether the impending decline in US consumer spending is the next big short and what will happen to the anticipated earnings from AI companies that the market is heavily banking on