Stocks surged on Friday, capping off an eventful trading week. Investors cheered after artificial intelligence darling Nvidia NVDA reported stellar first-quarter results on Wednesday, sending the company’s shares up nearly 13% for the week and underscoring the tech giant’s continued leadership in the market.
But strategists say cracks are appearing in other parts of the market as consumer spending slows. “We’re seeing signs that the consumer is weakening,” said Bryant VanCronkhite, senior portfolio manager at Allspring Global Investments. “That has big implications for the economy, for the markets, for everything.”
The weakness has some strategists questioning the bull market’s resilience in the coming months. “The question here isn’t whether NVDA, AI or tech in general are doing well – we can pretty much agree that they are,” Jonathan Krinsky, chief market technologist at BTIG, wrote in a client note on Thursday. “The question is whether it’s masking a deterioration in cyclical parts of the market, particularly consumer-related parts. If this weakness persists or widens into the summer, it will be hard for the market at large to ignore it.”
Consumers show signs of weakness
Strategists say the slowdown in spending among lower-income consumers has been going on for nearly a year. Now, middle-income consumers are showing signs of weakness. “You can clearly see the tension and stress,” said Katie Nixon, chief investment officer of asset management at Northern Trust. [companies] “What they’re seeing now that they didn’t see last quarter is even luxury-minded consumers becoming more price-conscious.”
Dave Sekera, chief U.S. markets strategist at Morningstar, points to Starbucks SBUX’s declining foot traffic and McDonald’s MCD’s weak performance as evidence of the trend. As pandemic-era savings have dried up, middle-income consumers are cutting back on purchases like lattes and fast food in favor of more economical options. “This is the first quarter that we’ve seen any real signs that middle-income consumers are starting to feel the compounding effects of high inflation,” Sekera explains.
Walmart’s strong first-quarter results are further evidence that consumers are looking for discounts. Krinsky also sees weakness in consumer discretionary sectors like homebuilding and hotels as evidence that consumers are cutting back on nonessential purchases. Meanwhile, consumer defensive stocks — staples like food and household goods — are outperforming their peers. The Morningstar U.S. Consumer Defensive Index is up 8.8% this year, while the Morningstar U.S. Consumer Cyclical Index is down 1.3%.
Could consumer weakness hurt AI stocks?
At first glance, consumer woes and the unstoppable growth of tech companies may seem unrelated. But consumer spending accounts for roughly two-thirds of the economy, Sekera said. “Over time, that’s going to slow the growth of the large, fast-growing tech companies,” he said.
It’s also worth remembering that for tech giants like Amazon AMZN, Meta Platforms META, Alphabet GOOGL/GOOG, and Microsoft MSFT, the majority of their revenue today comes from digital advertising, not artificial intelligence — and advertising only pays if consumers keep spending.
“If consumers don’t want to spend, everything slows down,” Van Cronkite said. This could hurt the tech leader’s growth. “If the economy weakens and consumer spending slows later this year, digital advertising could start to slow down. That could put pressure on it in the short term,” he said. But the continued flow of money into digital advertising instead of traditional advertising could mitigate this, he added. Needless to say, big tech companies are investing heavily in infrastructure for the future.
Stocks that can weather the consumer storm
Tech stocks’ returns look nearly unbeatable, despite the sector’s relatively high valuations. But strategists say investors looking to escape the ongoing spending slowdown should look to consumer staples. “I’m currently overweight consumer staples in all of my portfolios and underweight discretionary,” Van Ronkhite said. He stresses that Walmart is likely to benefit as luxury consumers continue to buy at lower prices and seek value.
Erin Rush, director of consumer equity research at Morningstar, points to Kraft Heinz KHC and Clorox CLX as two companies Morningstar analysts believe are undervalued. Rush says she looks at companies that are growing sales without deep discounts and that continue to pour money into research and development and marketing, indicators of investing in long-term success.
Overall, Sekera encourages investors to look for unusual names. He likes energy stocks, which he says are a strong hedge against geopolitical risk and inflation. He also likes communications stocks such as AT&T T and Verizon VZ, and defensive real estate names such as medical offices and hospitals.
Nixon believes investors should focus on quality in an uncertain economic environment: “We’re buying management teams that can solve whatever tail risks there are, economic or otherwise.”
Similarly, Van Cronkite recommends focusing on companies with strong, stable demand and strong balance sheets. “The consumer has been incredibly resilient for the better part of the last six to nine months,” he said, driving the economy and stock market to grow at a healthy pace. “When the consumer is no longer there, who is going to support that?” AI trading may provide some upside, but “is it big enough to help the overall market?”
