What retail problems indicate about the market’s fight against inflation

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Retailers are missing out and missing a lot. It started last week with results from Walmart and Target that showed significant inventory builds and the need for mass writedowns, followed by weak earnings and expectations from Abercrombie & Fitch sending its shares down in a similar fashion to what major retailers are taking. testing.

Is the canary hash in the coal mine for the market? There is good reason to ask the question, although it is still difficult now to answer it in the affirmative. Let’s start with the best-case scenario: The consumer is shifting in his spending habits from goods to services, and while retailers are preoccupied with the ebb and flow of their pandemic power, the latest chain of results is not a sign of consumer weakness — preferences are changing. Remember, no matter how much lower-income Americans struggle with inflation — their trade of premium-grade grocery shelves to private brands and steaks to pork, the shift Walmart has signaled is happening — two-thirds of consumer spending is done by one-third Americans in high-income groups.

Walmart and Target’s results could reflect changing financial realities for middle-to-low-income families in the face of high inflation, says Kathy Bostancik.And Chief US Economist at Oxford Economics. Conversely, higher-income households are less affected by the headwinds of inflation, and even if they feel some negative wealth effect, their balance sheets are still in very good shape.

“The level of their wealth and savings fueled by the pandemic will continue to support their robust consumer spending, especially as they continue to shift toward more personal spending on services,” she said, while the rotation of consumer purchases away from goods toward more services is hurting retailers such as Walmart and Target. In sales volumes, it is not a loss for the economy as a whole.

This view has been held as one of the keys to an economic slowdown that does not turn into a full-blown recession, and many economists still hold to it now.

“My unusual reaction is that a recession can be avoided,” said Scott Hoyt, senior director of Moody’s Analytics. ‘Upscale consumer is more rewarding.’

Best Buy said Tuesday that its forecast has weakened but it is not planning a “full recession.”

Home Depot’s results last week were the other side of the consumer equation, with spending on home remodels and from professional contractors boosting results.

A lower stock market will affect sentiment and privileged consumers have historically been sensitive to it, but this is a unique environment with excess savings, especially among older consumers who have been saving a lot of money in recent years as the pandemic has caused a hole in their spending, Hoyt said. “That doesn’t lessen my concerns about low-income people, but from an economic perspective, the upper class is more important, especially if there are still jobs. … if low-income people can’t afford pork because they don’t have a job. Then we have a real problem.”

Bostancik said that the retail sales/retail inventory ratios, even excluding autos, are not flashing warning signs that an unintended large build-up of inventories will begin in the near future to affect economic growth.

But it’s an economic data point that will attract more scrutiny given recent retail results.

“We’ve been talking for months about the fact that one of the biggest risks to the economic outlook is stock swings,” Hoyt said.

Hoyt said companies are so afraid of not having what they need that they err on the side of asking for “too much.” They double-arrange to have inventory in the door, and then as demand drops, they can end up with too much inventory and have to scale back and downsize existing inventory.

“This is the classic inventory cycle that has historically driven into recessions, not infrequently,” Hoyt said. “It’s been pretty clear in our minds for some time now.”

But, he added, this does not mean that the problems at Walmart and Target are “enough to say they exist and we can’t get out of them.” “We need to know how widespread it is.”

It’s a tough time for retailers, in particular, because there are reasons why the demand for goods is going down without the shift being the economic canary in the coal mine, commodity inflation being higher than service price inflation, and the economy still a long way from a pandemic transition. In spending from services to goods full reversal. “Even if I argued it wouldn’t completely reverse, it clearly hasn’t reversed to a level close to equilibrium. It’s a very challenging environment for retailers in particular,” Hoyt said.

These problems may get worse before school returns and the holiday season is better, and with the epidemic problems in China still making companies more anxious to have inventory. But if inflation continues to rise and inventory continues to grow in weaker demand, a worst-case scenario may be possible.

The government’s sales-to-inventory ratio data doesn’t suggest a problem yet, in fact, it’s still low by pre-pandemic standards. Hoyt said retail could be an example of an “isolated sector”. But he added, “It’s definitely a warning sign. This is a risk we’ve been aware of for a while and have confirmed is one that we have to follow closely, but I don’t know it says we’re entering a recession.”

The trend to watch, he said, is not the rise in inventory sales – it’s been too low – but how fast the rise is and how soon pre-pandemic levels are beginning to be exceeded. At the moment, “we are not very far from desired levels,” he said.

None of this can rule out the fact that Walmart has been out of business a lot — it was spotted with 32% more stock over the course of the year.

“It’s crazy,” Bill Simon, the former president and CEO of Walmart, told CNBC last week. I mean 8% would be loud, 15% would be awful, and 32% would be awful. I mean, this is a billion dollar stock. This is frankly not very well managed.”

The target was 43% higher.

“I think they were ordering to try and stay ahead of the supply chain issues and then the product came in and was late and they didn’t cut the orders on time, I mean there was a lot of things that could have been done frankly.”

But for Diane Swonk, chief economist at Grant Thornton, the market should receive retailer errors as a warning sign of something more fundamental and pervasive.

The axis of spending from goods to services, and the sensitivity of retailers to low- and middle-income families who feel disproportionately lower prices on things like gas, are real and acute issues. “People buy luggage instead of things they bought before, so all the things that benefited retailers, eased the misery of quarantine, are now backing out,” Sonk said. “The bulk of inflation is in the service sector, as is the bulk of spending, and it should slow in goods. Goods have experienced deflation until the pandemic,” she said.

But while that might help the Fed get some dip in commodity prices, it won’t cool the economy enough.

In the rapid stockpiling of large retailers, Swonk sees the inflationary economy perpetuating further booms and busts within it, and that should not assuage concerns about the macro environment. “The Fed is in a world that is now more prone to boom and bust,” Sonk said. “It’s as if the Fed went through a glass and couldn’t, like Alice, get up. He’s still in an alternate universe and won’t come back,” she said.

The resilience of the US economy may eventually cause the Fed to raise interest rates.

“We created 2.1 million jobs in the first four months of the year. This is a year [of job gains] “On average in the 2000s and a lot of their new paycheck,” Sonk said. “We’re not in a recession by any means yet,” she added, but more senior corporate economists aren’t talking as if they’ve gone by the look okay — taking profit margins based on higher costs even as price increases are passed on to consumers.

“That’s what happens,” she said.

The whip that Walmart and Target tested didn’t come out of nowhere and wasn’t limited to merchandise—Amazon packed staff as the world went out of omicron, a business factor that Walmart also noted in its disappointment with its recent earnings.

“Obviously these are important retailers and that’s important,” Sonk said.

Businesses will remain in the mentality of ‘we don’t know if we can get the goods now’ as ‘Zero Covid’ lockdowns remain an issue in China, and this will affect small and medium-sized businesses more than retail giants, who will discount them themselves. Big retail companies can better absorb the shock on margins, but being hit by high inventories and costs, still adds one thing to them: “Take it on the chin,” Sonk said.

Supply chain weaknesses don’t go away, and building in a pillow is expensive. “It’s been a long time since we’ve had anything like this,” said Sonk.

What the market knows for sure from the recent string of retail disappointments is that the axis from goods to services is underway, inflation is hurting lower-income households first, and this is starting to put pressure on business margins. But where does this pressure end?

This is the question that Swonk says the market already on the brink must answer.

The optimistic narrative was that the economy could hit that soft landing with the Fed’s “blunt” instruments and slow demand in a supply-constrained world with no hitches in the way.

“That novel is gone,” said Sonk. “The bumps are already there, even if parts of the economy benefit.”

Resorts are booked out for the summer and airlines are back after near collapse, and the switch to services is a major shift, but it’s also a reality test for the economy.

Stock market investors don’t care about the margin pressures independent restaurant owners face, but when it shows up at the nation’s largest retailers, investors start to worry about where else they’ll see margin pressure. “He hit a mole,” said Sonk. “And you’ll see that elsewhere.”

Inflation is now as much a problem for businesses as it is for families, and the situation can change with little pay. “It has changed in their favor for a while, but the reality is inflation is burning everyone down,” she said.

When large companies known for their low costs and known for their inventory and cost management feel the heat of inflation, this is a wake-up call, not an isolated event.

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