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What retail woes signal about the market’s fight against inflation?

Jay Laprete | Bloomberg | Getty Pictures

Retailers are missing and at great loss. started last week Walmart and Aim Results showing the need for large inventory increases and discounts and followed by weak earnings and outlook from Abercrombie & Fitch rolled over its shares, similar to what big-box retailers are experiencing.

The canary in the coal mine for the retail market? There’s good reason to ask the question, but it’s harder to answer in the affirmative right now. Let’s start with the best-case scenario: As consumers shift their spending habits from goods to services, and retailers are caught in the grip of the forces of the pandemic, the latest set of results is not a sign of a weakened crisis. consumer — changing preferences. Remember, no matter how low-income Americans struggle with inflation—trading from premium to private-label and steak to ham on grocery store shelves, a shift is taking place, as Walmart notes—two-thirds of consumer spending—one-third of Americans in the higher income quintiles.

Kathy Bostjancic says Walmart and Target results may still reflect changing financial realities for middle- and low-income households in the face of high inflation., Chief US economist at Oxford Economics. Conversely, high-income households are less affected by fluctuations in inflation and their balance sheets are still very good, even if they feel some negative wealth effect.

“The level of their assets and their pandemic-induced savings will continue to support strong consumer spending, particularly as we continue to shift towards more in-person service spending,” he said, adding that as consumer purchases continue to rotate toward more than goods, services are hurting retailers like Walmart and Target in sales volumes. It is not a loss for the economy as a whole.

This view has been cited as one of the keys to preventing the economic slowdown from turning into a full-blown recession, and many economists still adhere to it today.

“My reaction to the blow is that the recession can be avoided,” said Scott Hoyt, senior director of Moody’s Analytics. “The high-end consumer makes more sense.”

best buy He said his outlook weakened on Tuesday, but It is not planning a “full recession”.

Home Depotlast week results flip side of the consumer equationprofessional contractors that drive up the expense and results in home renovations.

The downturn in the stock market will affect sentiment and senior consumers have historically been sensitive to it, but this is a unique environment of extreme savings, especially among older consumers who have accumulated much more cash in recent years as the pandemic has created a vacuum. on spending, Hoyt said. “That doesn’t lessen my concerns about the people in the lower strata, but from an economic standpoint, especially if there’s still jobs, the upper strata are more important. … ham because they don’t have a job, then we have a real problem,” he added.

Bostjancic said that retail inventory/sales ratios, even excluding cars, do not give warning signs of a large undesirable increase in inventories, which will begin to put pressure on economic growth in the near future.

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 volatility,” Hoyt said.

Hoyt said companies are so afraid they won’t have what they need and make the mistake of ordering “too much”. They order twice to get inventory at the door, and then as demand softens they can have too much inventory and have to cut back on existing inventory and discount.

“This is the classic inventory cycle that has historically led to recessions and not infrequently,” Hoyt said. “It’s been very clear in our minds for a while.”

But that doesn’t mean that the problems at Walmart and Target are “sufficient to say it’s there and we can’t get rid of it.” “We need to know how common it is.”

It’s a tough time, especially for retailers, because there are reasons why demand for goods has softened without the economic canary shift in the coal mine, and goods price inflation remains higher than services price inflation, and the economy is still a long way from the pandemic shift in spending from services to goods completely reversed. “Even if you claim it will never fully reverse, it’s clear it hasn’t returned to near equilibrium. It’s a very difficult environment, especially for retailers,” Hoyt said.

These problems may worsen before they improve during the back-to-school and holiday season, and the ongoing pandemic problems in China are making companies even more anxious about owning inventory. But if inflation continues to rise and inventory continues to turn into weak demand, the worst-case scenario could be in the cards.

the government inventory sales rate data not yet a problem, in fact 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. It’s a risk we’ve been aware of for a while, and he stressed that we should be watching very closely, but I don’t know if he said we were going into recession.”

He said the trend to watch is not the increased inventory sales rate — very low — but how quickly it’s increasing and how far it’s starting to surpass pre-pandemic levels. At the moment, “we are not very far from desirable levels,” he said.

None of this can discount the fact that: Walmart is far behind — captured with 32% more inventory year over year.

“This is crazy,” Bill Simon, former Walmart president and CEO, told CNBC last week. So 8% would be high, 15% would be terrible, 32% would be apocalyptic. So that’s billions of dollars of inventory. It’s obviously not very well managed.”

The target was 43% higher; Abercrombie & Fitch inventory grew 45% year over year.

“I think they were ordering to stay one step ahead of the supply chain issues and then the product came and it came late and they didn’t cut the orders on time, I mean a lot of things could have happened, frankly if it hadn’t been done,” Simon told CNBC.

But according to Diane Swonk, chief economist at Grant Thornton, retailers’ mistakes should be taken by the market as a warning sign of something more fundamental and potentially pervasive.

The axis of spending on goods-to-services and the sensitivity of retailers to lower- and middle-income households who feel disproportionately pressed for prices on things like gas are real and acute problems. “People are buying luggage Everything that previously benefited the retailers, who had benefited from the things they bought, namely the retailers who eased the misery of the quarantines, is now being reversed,” said Swonk. Goods were deflationary until the epidemic,” he said.

But while that may help the Fed achieve some reduction in commodity prices, it doesn’t cool the economy enough.

Swonk sees rapid inventory increases at big-box retailers in an inflationary economy with more ups and downs in it, and that shouldn’t allay concerns about the macro-environment. “The Fed is in a more explosive world now,” Swonk said. “It’s like the Fed went through the mirror and couldn’t wake up like Alice did. He’s still in an alternate universe and won’t be back,” he said.

The resilience of the U.S. economy may ultimately increase the Fed’s bet on raising interest rates.

“We created 2.1 million jobs in the first four months of the year. That’s one year. [of job gains] On average, in the 2010s, and they were getting a whole bunch of new paychecks, Swonk said. “We’re by no means in a recession yet,” he added, but more corporate chief economists aren’t talking as if they’ve gone through a mirror. good — getting margin hits based on high costs, even when communicating price increases to consumers.

“This is it,” he said.

The whip that Walmart and Target experienced didn’t appear out of nowhere, and it’s not limited to merchandise — More staff on Amazon As the world exits Omicron, it’s a labor factor that Walmart points to disappointment in its recent earnings.

“These are clearly important retailers and they are important,” Swonk said.

As “Zero Covid” lockdowns are still a problem in China, firms will still have a “we don’t know if we can get the goods now” mentality and will hit these small and medium firms more than retail giants who will do their own discount. The big retail giants may be better able to absorb the shock on margins, but facing both high inventories and costs still adds something for them: “Getting it off the hook,” Swonk said.

Supply chain vulnerabilities are not going away, and creating a cushion is costly. “It’s been a long time since I’ve experienced anything like this,” Swonk said.

What the market knows for sure from recent retail disappointments is that the shift from goods to services continues and inflation hurts low-income households first, which in turn begins to squeeze operating margins. But where does this jam end?

This is the question Swonk says a market that is already on the edge will need to answer.

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

“This narrative has disappeared,” Swonk said. “The bumps are already there and even if parts of the economy benefit.”

Billionaire hedge fund manager Bill Ackman listed two options for the economy In a series of tweets Tuesday, Ackman said of the fight against inflation: “There is no possibility of a significant drop in inflation unless the Fed aggressively raises rates or the stock market crashes, precipitating an economic collapse and demand destruction.”

Resorts are booked for the summer and airlines are back after they almost went bust, and the shift to services is a big shift, but also a reality check for the economy.

Stock market investors don’t mind the margin pressures faced by independent restaurant owners, but when it shows up at the nation’s biggest retailers, investors begin to worry about where else they’ll see margin pressure. “The mole strike,” Swonk said. “And you’ll see it elsewhere.”

Inflation is now a big problem for businesses as well as households, and the situation can change on a dime. “It changed in their favor for a while, but the truth is inflation is burning everybody,” he said.

When large firms, known for low costs, known for inventory and cost management, feel the heat of inflation, it’s a wake-up call, not an isolated event.

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