Shoppers Are Getting Cheap. Here Are Stocks to Buy in a Trade-Down Economy

When did I turn this cheap? Just last year, I was flinging cash at house projects, big-screen fitness machines, and comfy clothes, while buying dressing eight ounces at a time like a Diamond Jim. Now the world has opened back up, but I’m shutting spending down, even though my financial circumstances are the same, notwithstanding this year’s inflation flare-up and stock and bond dipsy doodle.

Maybe I’m not alone. Economic signs look healthy enough—job growth, wages, even consumer spending. But the retail sector is abuzz about consumers trading down. After

Walmart

(ticker: WMT) beat earnings estimates this past week, it said that customers were buying less deli meat and more chicken, hot dogs, and canned tuna, and that U.S. stores were getting a lift from high-income shoppers stopping in for bargains.

CEO Doug McMillon mentioned excess inventory and markdowns, especially on apparel, and appeared to try to drum up interest during the earnings call. “It does surprise us how strong men’s flannel is, and we’ve got a program that’s just under $12,” he told analysts. “I bought two of them personally, and it’s a great value.”

BJ’s Wholesale

(BJ) reported results two days after Walmart, and CEO Robert Eddy called out his cold cuts. A shopper buying a pound each of sliced turkey and cheese a week can save $260 a year versus the competition—almost five times the base membership fee, he said on the call. Results were strong overall. BJ’s is pumping 40% more gallons of discounted fuel than two years ago. Same-store sales excluding fuel increased by 7.6% year over year. Management reached its target of 25% penetration for its store brands, so it raised the target to 30%. Shares jumped 7%.

TJX Cos.

(TJX), which specializes in buying marked-down garments from chains and manufacturers that are overstocked, also reported quarterly results. Sales missed estimates, but earnings beat them, and the report was well received.

Jefferies

says that TJX is poised to gain market share amid what are likely to be clothing order cancellations ahead.

Dollar General

(DG) and

Dollar Tree

(DLTR) report results this coming Thursday. Both probably gained share during the second quarter because their core customers were squeezed by inflation, reckons UBS analyst Michael Lasser. “We also suspect higher-income cohorts crossed over to dollar stores in pursuit of better value,” he wrote in a note.

For folks on tight budgets, frugality is a way of life. But why are those with more breathing room trading down? Perhaps inflation is reason enough. Personally, I can’t shake the feeling that bear markets are supposed to be more painful. We’ve already bounced halfway back from the one that hit bottom in June. Where’s the despair?

BofA Securities points out that every new bull market since 1935 has started when something called the Rule of 20 was satisfied. Add the stock market’s trailing price/earnings ratio to the year-over-year inflation rate and if the sum is under 20, investors and consumers are sufficiently gloomy. By my math, we never got below 24. Either the rule is broken or we need cheaper stocks or less consumer demand, or both.

The Rule of 20 is one bull market signpost on a longer list of them that

BofA

tracks—things like the Fed cutting interest rates, and a key manufacturing survey showing improvement. This past summer, we hit only 30% of the signposts; the long-term average before new bull markets is 80%.

If I’m wrong to be wary of a coming trade-down economy, kindly dismiss this as a thesis inventory closeout from a man headed out the door for a two-week vacation. If I’m right, the stock to favor from the ones already mentioned might be BJ’s, which trades at 15 times free cash flow. It sells a lower mix of discretionary items than Sam’s Club and

Costco Wholesale

(COST), and a higher mix of food, which is a drag during a zippy economy but just what investors want when shoppers forgo wants in favor of needs.

“Needs” here is subjective at a store that sells Famous Amos cookies in 42-pouch boxes, but you get the idea. You might even find me at BJ’s in the months ahead, although not near the dressing anytime soon. Look for the guy wearing the $12 flannel shirt.

One analyst I spoke with remains bullish on subscriptions—or at least on a handful of companies that combine memberships with franchise business models and fragmented industries. Randal Konik at Jefferies calls

Planet Fitness

(PLNT) the Walmart of the gym industry for its $10 monthly dues. He sees gyms as poised for a comeback versus connected fitness players like

Peloton Interactive

(PTON), the bike company. “I’m trying to sell mine, and I can’t find any buyers,” he says.

Konik also likes

Mister Car Wash

(MCW), which has amassed 10% market share using monthly payments. “You could theoretically cancel your car-wash membership during a downturn, but if it costs $15 to $20 a month, that’s a few frappuccinos at

Starbucks
,
” says Konik.

Then there’s

European Wax Center

(EWCZ), which I’ve learned has nothing to do with automotive detailing. It handles the other kind of waxing using a buy-nine, get-three-free model. There’s also an Annual Unlimited Wax Pass for depilation die-hards. I didn’t ask about demand elasticity, but if it’s anything like lawn care, once you turn the job over to professionals, it’s difficult to go back.

Write to Jack Hough at [email protected]. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.