KBRA Financial Intelligence

3 Things in Credit: Behavioral Drag, Growth Fuel, and Walmart’s Significance

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about. So, it’s just another quiet August, right? If you were lucky enough to sleep through the past two weeks, you would have awakened to a VIX that went from 18 to 15, the S&P 500 that is essentially unch’d, and high-yield credit spreads that drifted a touch wider. Best to keep moving, there’s nothing to see here!

This week, our 3 Things are:

1. Behavioral drag. Risk appetite changes as growth slows.

2. Growth fuel. You’ll miss these things when they’re gone.

3. Walmart’s significance. Macro signals from a bellwether.

Alright, let’s dig a bit deeper.

Behavioral drag.

In past cycles, we found it useful to think about how risk-takers change behavior as the cycle turns. The risk-takers we care about, of course, are consumers, business managers, and investors.

On the consumer front, we want to explore what is driving their spending decisions? Are they spending more, the same, or less as a result of what they are experiencing and seeing? Do they have the confidence to borrow or are they hunkering down? For business managers, are they investing in their business by hiring more workers and spending on property, plant, and equipment? Are they increasing leverage? And how about investors? Are they exhibiting risk-on or risk-off behavior? Is their behavior easing or tightening financial conditions?

Now, think about how those outcomes change in different parts of the cycle. If we’re growing at a healthy clip, say at 2.5%, risk-takers can’t see recession, so they are more likely to spend, borrow, and invest accordingly. Think of it as a flywheel effect, with optimism fueling momentum.

Now, think about behavior as growth slows. Here, two guideposts pop up. First, growth’s direction of travel—it’s negative. Will it fall through the floor? They might not think so, but they can’t say for sure. So, they’ve got to take that into consideration. The second guidepost is recession. If we’re growing at 1.5%, they can see recession much more clearly than when we’re growing at 2.5%. So, our risk-takers change behavior. Consumers grow less secure about job status and wage gains. Responsible consumers curtail discretionary spending and trade down on purchases. They pay down debt. Less responsible consumers burn through savings and tap out borrowing capacity. Taken together, we get less spending.

Similarly, at low and/or declining economic growth, businesses grow conservative, postponing expansion plans and focusing on managing down the expense line. And last time I looked, no one ever cut their way to prosperity. Economic output slows.

And investors adopt more of a risk-off mindset, moving up in quality and increasing the scarcity of cost-effective capital. Growth slows.

So, where do we find ourselves? Well, we’re in the growth-moderating camp, even with that surprise Q2 GDP report that came in at a super strong 2.8%, and with the Atlanta Fed GDPNow estimate for Q3 hovering at 2.9%. We believe real demand destruction has taken place in interest-sensitive sectors such as housing, and we believe higher rates are leaning on levered consumers and businesses. And the trends in the labor market, from rising unemployment to fewer job openings to moderating wage gains, are beginning to impact consumer behavior, something we now see showing up in a range of consumer products and services, company earnings, and guidance, where staples are in and discretionary spend—especially in travel and leisure—is out. It’s happening at the micro level, so it must be happening at the macro level as well. It argues for moving up in quality in credit.

Alright, on to our second Thing—Growth fuel.

With inflation concerns firmly in the rearview mirror, market attention has shifted to growth, or lack thereof. Now, to be clear, economic and corporate earnings growth has been better than expected, and the forward looks are reassuring, be it via The Wall Street Journal’s latest survey of economists, which is calling for economic growth of a still reasonably solid 1.9% in 2025, or Bloomberg consensus calling for 2025 earnings growth for the S&P 500 of 14.1%.

Still, headwinds are clearly building. Monetary tightening may be on course to ease, but rates certainly aren’t going back to ultra-low levels unless growth falls off a cliff. So, cost of capital figures to remain materially higher than the days of zero interest rate policy. Meanwhile, bank lending standards are easing off shock levels of tightening we saw post the failures of three midsized banks in 2023. Nevertheless, a slowdown is sure to put an end to that trend.

In addition, two other sources of growth fuel—excess savings from pandemic-era relief programs and fiscal stimulus—have both run dry, according to research we saw recently.

On the excess savings front, a new report out of the San Francisco Fed says that “liquid wealth,” the asset class most easily converted to consumer spending, has fallen below pre-pandemic levels on an inflation-adjusted basis for both wealthy households as well as middle- to lower-income households. Moreover, and not unrelated, the end of excess savings has coincided with an increase in household debt to all-time highs. And card net charge-offs have jumped to the highest levels since the GFC, despite unemployment at historically low levels.

On the fiscal stimulus side of things, Brookings expects the effect of fiscal policy on growth in the U.S. to become roughly neutral in the fourth quarter of 2024, then increasingly become negative, to as much as a drag of -0.5% on GDP through the end of the forecast period in the second quarter of 2026. Its findings are reflected in its Fiscal Impact Measure, which estimates the effect of fiscal policy—changes in taxes and spending at federal, state, and local levels—on real GDP growth. Safe to say, bond vigilantes are standing by to enforce fiscal discipline, even if politicians on both sides of the aisle see no evil.

So, when you combine my first Thing—behavioral sensitivity—with the growth headwinds we just outlined, there are reasons to be cautious. But it’s also important to dimension the downside, which we continue to see as slowdown but not recession.

Alright, on to our third Thing—Walmart’s significance.

We don’t often see a non-tech, bellwether megacap’s stock outperform the S&P 500 by 6% on an earnings release, especially when said megacap was already up 31% on the year. So is the case with Walmart. Management characterized the results as “another good quarter with strong sales growth and even stronger profit growth exceeding our expectations.”

What drove the stock performance today (and probably all year) has been the company’s ability to satisfy the changing needs of its ever-expanding base of customers. That’s no small feat when your customers are a broad swath of society. In its latest quarter, the company grew adjusted operating income by 7.4% year-over-year on revenue growth of 4.9%. EPS beat the estimate by 5%. Perhaps more importantly, the company raised its full-year guidance for sales, operating income, and net income.

What to make of this?

Management’s observations:

1. Americans continue to be discerning, choiceful, value-seeking, and focused on essentials.

2. Customers from all income levels are looking for value.

3. We aren't experiencing a weaker consumer overall. We have not seen any additional fraying of consumer health.

4. Given the state of the economy, the election, and state of affairs globally, there's reason to be appropriately measured in our outlook for the back half of the year.

Our observations:

1. The main engine of U.S. growth, the consumer, is slowing.

2. Middle- to lower-income customers are overwhelmingly employed and have enjoyed wage gains, the combination of which has allowed them to offset the impact of inflation.

3. The company has been a beneficiary of higher-income households becoming more value conscious.

4. What’s going on at the macro level is weighing on consumer sentiment.

From our perspective, Walmart’s results (and guidance) were sufficiently buoyant to support a soft-landing scenario, but also sufficiently sobering to suggest that the halcyon days of stimulus-fueled growth are behind us. It is worth noting that this release reflects an economic backdrop that is for the most part highly constructive, with above-trend growth and a highly favorable labor market. We know the growth part of that equation is set to slow. Walmart is well positioned to ride this correction out. There is less certainty around cyclicals—consumer discretionary, industrials, and materials.

So, there you have it, 3 Things in Credit:

1. Behavioral drag. Keep an eye out for where the sentiment tipping point is for risk-takers.

2. Growth fuel. There is less of it to go around.

3. Walmart’s significance. What’s good for Bentonville is not always good for the broader economy.

As always, thanks for joining. We’ll see you next week.