9 Stocks I’m Buying As Consumer Spending Stalls

domin_domin/iStock via Getty Images Once again, I’m feeling like a mosquito in a nudist colony… where do I begin? There’s a veritable buffet of information to imbibe this week, so I won’t waste time by way of introduction. Here’s the table of contents: Stock market breadth is thinning faster than George Costanza’s hairline Consumer vs. economist views of inflation; cumulative vs. rate of change The consumer spending slowdown My buy list going into the last week of June See you in the comments section! Thinning Up Top Sometimes stock market performance correlates pretty well with the general economy. Other times, though, the market cap-weighted stock indices are deceptive, portraying economic strength when there is actually a broad amount of weakness under the surface. Today, the stock market is being driven by a handful of mega-cap corporations while most of the market is piddling along or falling. The market cap-weighted S&P 500 (SPY) has risen 15.5% since the beginning of 2022, while the S&P 500 Equal Weight ETF (RSP) has risen only 1.5%. Data by YCharts As you can see, the divergence between the two is growing. Concentration at the top is already at incredible levels and only increasing. The top 10 largest names in the S&P 500 make up about 35% of the index. Torsten Slok In other words, market breadth is extremely thin. Most stocks are falling or rangebound, while a handful are soaring. Sherwood Media As you can see from this scatterplot above, the current situation in which the S&P 500 is rising while breadth is falling is quite rare. Of course, anyone not living in a cave knows that this is the AI trade. Artificial intelligence has propelled a handful of cash-rich mega-cap tech stocks with the money, expertise, and network effects to lead the way on AI adoption to ever greater heights. Chartr The latest beneficiary has been Apple (AAPL), which may not be developing its own AI software but is integrating existing AI applications such as ChatGPT into its vast and user-friendly hardware ecosystem. This makes a lot of sense to me. Why reinvent the wheel when your specialty is horse husbandry? (Hopefully the wagon metaphor makes sense.) Why try to make your own AI software when your specialty is user-friendly devices? The bottom line here is that stock market leadership has thinned to a small number of mostly AI-related companies. This gives the misleading perception that the economy is booming when really only the small but burgeoning AI economy is booming. Inflation: Consumer Vs. Economist Perspectives It has become exceedingly clear to me over the last year or so that consumers and economists have very different conceptions of inflation. They care about two different things. Consumers care about cumulative inflation, while economists are focused on rate of change inflation. I said in last week’s article, “9 Stocks On My Buy List As Fed Rate Cuts Approach,” that the post-COVID inflationary surge is over and that now it is just a matter of time before the CPI corresponds to this reality. As Exhibit A, I present this lovely chart from WisdomTree showing the headline and core CPI using the Bureau of Labor Statistics’ lagging shelter data versus real-time shelter price data collected from the private sector: WisdomTree As you can see, using real-time, private-sector rent rate data instead of the BLS’s severely lagging shelter metrics, inflation has already been below 2% for a year or longer. And yet, every time I point out that inflation (accurately measured) has been tamed, I get lots of pushback from folks saying, “Inflation hasn’t gone down! Eggs are still $8 a carton!” Let’s say a carton of eggs surged from $3 before COVID to $8 in 2023 and has stayed at $8 over the last year or so. (I don’t eat eggs, so these prices are guesses.) An economist would say inflation in eggs is now zero, because the price of eggs has stayed the same over the last year. But the average person is still upset about how much and how quickly the price of eggs soared in the preceding years. Here’s a chart illustrating this phenomenon: The Daily Chartbook Lots and lots of data shows that the rate of change in consumer prices has come back to around 2% or lower. But the price of eggs and restaurant menu items and cars and all sorts of other things are not going back to where they were in 2019, and they almost certainly never will. The US M2 money supply is 36% higher today than before COVID-19. With that much more money circulating in the economy, how in the world are prices supposed to go back to 2019 levels? I don’t like higher prices either, but I find it totally unreasonable to believe that prices will ever go back to 2019 levels, or that the Fed should keep interest rates high until prices completely retrace all gains over the last four years. The way out of this unhappy situation won’t be a return to the Before Times — those halcyon days of yore when eggs only cost $3. It will be for incomes to keep steadily rising while consumer prices stay relatively flat until $8 seems like a normal price for eggs. Consumer Spending Is Slowing Down I’ve been saying for several months that consumers are broadly losing steam and pulling back on spending. This, along with interest rates at cycle highs and labor market softening, leads me to the strong belief that the US economy is definitely late-cycle, not early-cycle or in recovery. Indeed, with consumer spending and job gains having been hot the last few years, I don’t really see what we would even have to recover from. There has been no recession. I do think, though, that a recession is still coming, even if it is taking a lot longer than I thought to arrive. One argument we still hear from the economy bulls is that the consumer remains extraordinarily cash-rich. Just look at how much more households have in cash and checkable deposits today than before COVID-19: St. Louis Fed As of Q1 2024, the American consumer still had over $3 trillion more in the bank than before COVID-19! This gets to a pet peeve of mine in the public discourse around economics, and that is when pundits treat “the consumer” as one monolithic individual, as if all ~132 million US households had the same income, savings, assets, and spending power. I’m about to trigger some folks out there, but I am committed to telling the truth as I see it whether it triggers people or not. There is an absolutely gargantuan range in spending power between the poorest and the richest people in the US. COVID-19 and the fiscal and monetary policy response to it has greatly increased this inequality. The chart above implies that every man, woman, and child has about $12,300 in their bank account — if the money is split equally. But to think that the distribution is even remotely equal is to succumb to the tyranny of averages. Consumers need to be broken out into at least two groups: Affluent consumers (~40% of the population) Paycheck-To-Paycheck (P2P) consumers (~60% of the population) Affluent consumers, especially older ones, went into the pandemic already owning a home (which they purchased when both home prices and mortgage rates were much lower), already having a sizable sum of invested assets in retirement accounts or elsewhere, and already having plenty of cash in the bank. Today, the Affluent’s real estate and stocks are worth far more, their sole source of debt (if any) is a mortgage with a 3-4% interest rate, and their cash is generating more interest income than anytime in living memory. In fact, the Affluent are generally earning a higher interest rate on their cash than they are paying on their mortgage! Meanwhile, P2P consumers are more likely to rent, have few assets, have little to no savings, and have various forms of consumer debt (credit cards, auto, student, etc.). While P2P consumers temporarily benefited from stimmy checks and enhanced unemployment benefits during COVID, that influx of cash is now depleted while the prices of virtually everything are much higher. P2P consumers did not benefit from the increase in home and stock prices, because they own little to none of these assets. In fact, now it is a lot more expensive to become a homeowner, car owner, or shareholder. Deloitte And, while the Affluent are generating 5%+ interest on their cash, P2P consumers by and large have no cash on which to earn interest and instead are paying more and more interest on their credit card, auto, and student debt. So, is “the consumer’s” balance sheet strong? Is “the consumer” cash-rich? Yes and no. The Affluent are extremely cash-rich and have extraordinarily strong household balance sheets. If they are pulling back on spending, it is mostly by choice. You can only take so many vacations before you need a break, and your closet can only hold so many Louis Vuitton purses. Then again, some of the lower end of Affluent consumers (or the higher end of P2P consumers) may be starting to feel the pinch. A recent consumer survey showed that grocery shoppers earning over $100,000 per year have increased their preference for Walmart (WMT) over pricier alternatives this year. Former Walmart US CEO Bill Simon says this is because money is getting tight for most people, including some high-income consumers. Meanwhile, P2P consumers are doing poorly. They are reining in spending by necessity. That’s the main reason why the US personal saving rate is so low, credit card debt is soaring, and credit/auto loan delinquency rates are on the rise. Likewise, several important consumer spending metrics demonstrate the weakness of at least some consumers, presumably in the P2P camp. In May, reported retail sales rose a mere 0.1% month-over-month while April’s number was revised down to -0.2% MoM. But that is a nominal number. Since so much of nominal sales have come from price hikes over the last several years, I insist upon looking at real (inflation-adjusted) sales numbers. As discussed in “Everything On My Buy List For The First Week Of June,” real retail and food service sales have only ever fallen or even plateaued during recessions. Real retail sales peaked in the late Spring of 2021, right after the last stimmy check went out, and have been on a slow, gradual, downward slide since then. Data by YCharts Real food service sales growth hung in there for a while longer as people indulged in post-pandemic “revenge spending” into 2022 and 2023. But as you can see in the chart below, nominal sales at “food services and drinking places” (translation: restaurants and bars) have been slowly declining since reaching a peak in late 2023. Data by YCharts Now, this downward slide in restaurant and bar sales hasn’t lasted that long yet, but keep in mind that nominal restaurant and bar sales usually don’t even decline during recessions. At least, not meaningfully. In both the early 2000s recession and the GFC, total restaurant and bar sales basically just flatlined for a few years before returning to growth. The last holdout of consumer spending is travel and leisure. But since these services are primarily enjoyed by Affluent consumers, I wouldn’t expect these areas to weaken much, even if the economy does go into recession. I find it plausible that the next recession is one suffered almost entirely by the paycheck-to-paycheck segment of the population. On that cheery note, let’s turn to my buy list for the fourth and final week of June. My Buy List This Week I won’t regale you with a full-throated rehash of my investment philosophy, but the basic formula is this: Buy high-quality companies that pay a growing dividend at a discount to fair value (and thus an attractive dividend yield) and wait patiently as they compound over time. In truth, though, this applies only to the main portion of my portfolio — steady compounders, or what I call “rowers.” I also own plenty of “sails,” which are high-yielding securities (common stocks, preferred equities, bonds, or anything else) from which I expect only high income, not growth of income. Since my portfolio is already pretty stocked up on “sails,” the focus of my buying right now is on those high-quality, steady-compounding “rowers” that should generate strong and consistent dividend growth indefinitely into the future. Dividend Yield Projected Future Div Growth Range (Guesstimate) American Homes 4 Rent (AMH) 2.9% High-Single-Digit American Tower (AMT) 3.3% High-Single-Digit Brookfield Asset Management (BAM) 4.0% Low-Double-Digit Cullen/Frost Bankers (CFR) 3.7% Mid- to High-Single-Digit Comcast (CMCSA) 3.3% Mid- to High-Single-Digit InvenTrust Properties (IVT) 3.7% Mid- to High-Single-Digit Rexford Industrial (REXR) 3.8% High-Single-Digit to Low-Double-Digit Sempra (SRE) 3.3% Mid- to High-Single-Digit Essential Utilities (WTRG) 3.3% Mid- to High-Single-Digit Click to enlarge I know many of my readers are retirees or near-retirees more interested in current income than growth of income. For those folks, I’ll mention that there are a handful of preferred stocks with higher yields that I find quite attractive right now: Dividend Yield Upside To Par KKR Real Estate Finance 6.5% Series A (KREF.PR.A) 8.8% 35.4% Arbor Realty Trust 6.25% Fixed-to-Floating Series F (ABR.PR.F) 7.8% 24.8% Gladstone Land 6% Series C (LANDP) 7.3% 22.1% Rexford Industrial 5.875% Series B (REXR.PR.B) 6.9% 17.1% American Homes 4 Rent 6.25% Series H (AMH.PR.H) 6.5% 4.8% Click to enlarge If my primary goal was to maximize current income, these are some names I’d be buying right now. Comparing Apples To Apples In Capex-Heavy REITs Real estate investment trusts are my wheelhouse, my bread and butter. But I must say, comparing bottom line profits from one REIT sector to another is not easy. The standardized accounting metric for REITs is funds from operations (“FFO”), which is basically net income with amortization & depreciation (which landlords have a lot of) and a few other non-cash expenses added back in. But there are plenty more adjustments that need to be made to get to a true cash profits metric. If you truly want to compare bottom-line apples to bottom-line apples in the REIT space, you’ve got to look at AFFO per share. Some REITs do the work for you by reporting AFFO per share. It’s typical in the net lease space, because there aren’t that many adjustments that need to be made anyway. But in capex-heavy sectors like residential, industrial, and retail (among others), a little extra work is required to get to AFFO per share from their reported FFO metrics. Let’s look at a few examples. Rexford Industrial REXR reports core FFO, which does make some helpful adjustments from the standardized FFO metric, but this metric does not include leasing & maintenance capex. Fortunately, REXR also reports total AFFO (which takes out leasing & maintenance capex), and it also reports weighted average shares outstanding, which just leaves the simple math of calculating AFFO per share. REXFORD INDUSTRIAL Total AFFO Weighted Avg Shares Outstanding AFFO Per Share Q3 2020 $34.2m 123.84m $0.28 Q4 2020 $38.6m 126.40m $0.31 Q1 2021 $41.1m 131.76m $0.31 Q2 2021 $43.4m 134.82m $0.32 Q3 2021 $51.0m 139.63m $0.37 Q4 2021 $59.1m 153.87m $0.38 Q1 2022 $67.1m 161.05m $0.42 Q2 2022 $66.8m 165.20m $0.40 Q3 2022 $68.4m 172.83m $0.40 Q4 2022 $75.2m 184.56m $0.41 Q1 2023 $86.0m 195.78m $0.44 Q2 2023 $86.6m 200.67m $0.43 Q3 2023 $84.9m 205.45m $0.41 Q4 2023 $95.0m 210.36m $0.45 Q1 2024 $105.1m 214.44m $0.49 Click to enlarge REXR is a low-debt company that mostly relies on equity issuance for external growth. Hence why total AFFO has tripled since Q3 2020 while AFFO per share has risen by “only” 75%. Here are the last three full years of AFFO per share plus the dividend payout ratio: 2021: $1.38 (70%) 2022: $1.63 (79%) 2023: $1.73 (88%) REXR is trading at a forward AFFO multiple of around 22.5x, assuming 2024 AFFO per share of about $2.00. That doesn’t sound cheap until you realize that REXR’s average AFFO multiple from the last five years has been 39x. Maybe 39x was too much to pay for REXR, but I’m convinced that 22.5x is an exceedingly cheap price to pay for REXR, given its quality and growth potential. “Wait,” you might object. “You think it’s a good idea to buy REXR at a 4.5% AFFO yield? Seriously?” If REXR had little to no growth potential, then yes, a 4.5% AFFO yield would not be nearly high enough. But REXR isn’t a bond. It’s a growing company. REXR’s total portfolio NOI is expected to rise by almost 50% over the next three years based on organic sources (mark-to-market rent, redevelopment, embedded rent escalators, and lease-up) alone. That doesn’t include any external growth from future acquisitions. InvenTrust Properties I explained in a recent article “Why InvenTrust Properties Is My Top Pick Among Shopping Center REITs,” but I realized after writing it that I did not perform a historical analysis of the REIT’s AFFO per share results. Quite an oversight on my part. Mea culpa. Upon performing such an analysis, I found myself surprised by the result: INVENTRUST PROPERTIES Core FFO Leasing & Maint. Capex AFFO Wtd Avg Shares Outstanding AFFO Per Share Q2 2021 $23.89m $4.93m $18.96m 72.04m $0.26 Q3 2021 $27.32m $5.10m $22.22m 71.40m $0.31 Q4 2021 $26.28m $7.76m $18.52m 69.12m $0.27 Q1 2022 $29.01m $5.62m $23.39m 67.58m $0.35 Q2 2022 $28.63m $7.07m $21.56m 67.55m $0.32 Q3 2022 $25.22m $5.51m $19.71m 67.55m $0.29 Q4 2022 $23.08m $7.12m $15.96m 67.43m $0.24 Q1 2023 $27.37m $5.21m $22.16m 67.65m $0.33 Q2 2023 $29.05m $9.32m $19.73m 67.52m $0.29 Q3 2023 $27.64m $8.62m $19.02m 67.53m $0.28 Q4 2023 $27.79m $8.04m $19.75m 68.09m $0.29 Q1 2024 $29.98m $5.86m $24.12m 68.27m $0.35 Click to enlarge Here’s IVT’s AFFO per share by year, along with the dividend payout ratio: 2020: $1.13 (67%) 2021: $1.08 (72%) 2022: $1.19 (69%) 2023: $1.19 (72%) IVT’s annual AFFO per share ranges between 70-80% of core FFO per share, meaning that the REIT is consistently spending 20-30% of core FFO per share on leasing and maintenance costs. Rents have grown nicely, but so have the costs of leasing commissions and tenant improvements (i.e. building out particular spaces to suit incoming tenants). Wow! In order to keep a 72% payout ratio, given the estimated 2024 dividend of $0.91, IVT would need to generate AFFO per share of $1.26 this year. IVT May Presentation My thesis for IVT has been that its dividend growth rate could increase from the mid-single-digits to the high-single-digits, but that may not be possible. Much of the growth in core FFO may continue to go toward leasing commissions and construction contractor bills for tenant buildouts. The bull case for IVT seems to be either that (1) tenant improvement / buildout costs will decline as rents continue to rise, or (2) tenant retention will greatly increase, thus decreasing churn, or both. If this bull thesis does play out, then perhaps AFFO per share and dividend growth will begin to grow at a faster pace. But if churn doesn’t meaningfully decline, and if leasing & maintenance costs continue to rise, then AFFO per share growth will likely continue to be minimal and lumpy. At a forward AFFO multiple of about 19.5x, IVT seems to be valued like a REIT that can grow in the high-single-digits. It really puts relative valuations across REIT sectors in perspective. My largest holding of Agree Realty (ADC), which is also focused on retail real estate albeit in single-tenant net lease instead of multi-tenant shopping centers, currently trades at an AFFO multiple of about 15x — cheaper than IVT by 4.5 handles. And yet, ADC has almost no tenant turnover and barely ever has to pay leasing commissions or tenant buildout costs. ADC and IVT have basically the same payout ratio (low 70% area), and yet ADC yields 4.9% while IVT yields 3.7%. Hmmm. American Homes 4 Rent AMH is a landlord and developer of single-family rentals (“SFRs”), concentrated largely though not entirely in the Sunbelt region. Unlike its primary SFR REIT peer of Invitation Homes (INVH), AMH is a top 40 homebuilder in the US that can churn out some 2,000 homes per year. These SFR homes are constructed in neighborhoods that combine single-family living with all the amenities of Class A apartment communities, such as clubhouses, fitness centers, swimming pools, and playgrounds. Given low homebuying affordability, I believe these built-to-rent neighborhoods will attract a sizable segment of Millennials entering their prime single-family years of life. Tenant turnover at SFRs is lower than for apartments. Residents tend to stay in SFRs for 3-5 years, while the average stay in an apartment is about 2 years. That makes SFRs’ turnover or “make-ready” costs lower than for apartments, but there’s still capex here that needs to be deducted from core FFO to arrive at AFFO. Fortunately, AMH has made it easy for us. They report AFFO per share in their quarterly supplemental packages. AMERICAN HOMES 4 RENT Core FFO Per Share AFFO Per Share Q1 2022 $0.38 $0.35 Q2 2022 $0.38 $0.34 Q3 2022 $0.39 $0.33 Q4 2022 $0.40 $0.35 Q1 2023 $0.41 $0.37 Q2 2023 $0.41 $0.36 Q3 2023 $0.41 $0.35 Q4 2023 $0.43 $0.39 Q1 2024 $0.43 $0.40 Click to enlarge We can see a general upward trend in AFFO per share on a quarterly basis, but it’s easier to see when you zoom out to look by year (with payout ratios): 2016: $0.84 (24%) 2017: $0.90 (22%) 2018: $0.92 (22%) 2019: $0.99 (20%) 2020: $1.02 (20%) 2021: $1.22 (33%) 2022: $1.37 (53%) 2023: $1.47 (60%) Assuming an AFFO per share of $1.60 for 2024, AMH’s payout ratio would rise a bit to 65%, which is still quite comfortable and leaves plenty of retained cash flow. At a price of $36, AMH trades at a somewhat lofty AFFO multiple of 22.5x, but that is still much cheaper than the 35x multiple reached in 2021. And given that SFRs currently sell for cap rates in the high-4% area, a 4.4% AFFO multiple for AMH seems appropriate. I won’t call AMH “cheap,” but I think it’s fairly valued. As a long-term hold, I’m okay with paying a fair price for this wonderful company.

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