What retail inventory lacks, say inflation-fighting rebates

Jay Laprete | Bloomberg | Getty Images

Retailers are missing and missing big. It started last week with the Walmart Other Target results that showed large inventory builds and the need for reductions, and was followed by weak earnings and prospects from Abercrombie & Fitch which caused its shares to collapse in a similar way to what large retailers have experienced.

Is retailing the canary in the coal mine for the market? There are good reasons to ask the question, although right now it remains more difficult to answer in the affirmative. Let’s start with the best-case scenario: the consumer is shifting their spending habits from goods to services, and while retailers have been impressed by the ebbing tide on the strength of their pandemic, the recent streak isn’t the sign of a consumer weakening – preferences are changing. Remember, no matter how low-income Americans struggled with inflation – swapping grocery store shelves from premium to private label and steak to ham, a shift Walmart indicated was happening – two-thirds of consumer spending is made by one-third of Americans in the higher income brackets.

Walmart and Target Findings Could Reflect Changing Financial Realities for Lower and Middle Income Families in the Face of Still High Inflation, Says Kathy Bostjancic, US chief economist at Oxford Economics. Conversely, higher-income households are less affected by headwinds to inflation, and while they experience a negative wealth effect, their balance sheets are still in good shape.

“The level of their wealth and savings fueled by the pandemic will continue to support their heavy consumer spending, especially as they continue to shift towards greater spending on personal services,” he said, and as the rotation of consumer purchases from goods to services harms retailers like Walmart and Target in sales volumes, not a loss to the economy as a whole.

This view has been considered one of the keys to an economic slowdown that does not turn into a total recession, and many economists continue to support it.

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

best buy he said on Tuesday that his prospects have weakened, but it is it is not planning a “full recession”.

HomeDepotThe results last week were the flip side of the consumer equationwith expenses for home renovations and professional contractors increasing results.

The decline in the stock market will weigh on sentiment and high-end consumers have historically been sensitive to it, but this is a unique environment with excessive savings, especially among older consumers who have been putting away much more money in recent years when the pandemic has hit. created a hole in their spending, Hoyt said. “That doesn’t lessen my worries about low-end people, but economically, the high-end is more important, especially if there are still jobs. … If low-end people can’t afford ham because they don’t have a job, so we have a real problem, “he added.

Inventory / retail ratios, even excluding cars, are not flashing warning signs that there is a large involuntary build-up of inventory that will begin to weigh on economic growth in the near future, Bostjancic said.

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

“We have been talking for months that one of the biggest risks to the economic outlook is a swing in inventories,” said Hoyt.

Companies are so afraid of not having what they need that they are wrong on the side of ordering “a lot,” Hoyt said. They double up the order to get inventory at the door and then, when demand subsides, they can end up with excessive inventory and having to shrink and shrink existing inventory.

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

But that doesn’t mean Walmart and Target’s problems are “enough to say they were there and we can’t get out of it,” he added. “We need to know how pervasive it is.”

It’s a tough time for retailers, in particular, because there are reasons why demand for goods should be eased without change being the economic canary in the coal mine, and commodity price inflation has been higher than that. in service prices and the economy is still a long way from the shift in pandemic spending from services to goods to fully reverse. “While it is argued that it will never completely reverse, it clearly hasn’t returned to near equilibrium. It’s a very complicated environment for retailers in particular,” Hoyt said.

These problems could worsen before going back to school and during the holiday season, and with persistent pandemic problems in China making companies even more anxious to have stocks. But if inflation continues to run and stocks continue to create weaker demand, the worst case scenario may be in the cards.

The government Inventory / sales report data does not yet suggest a problem, in fact, it is still low by pre-pandemic standards. Retail can be an example of an “isolated sector,” Hoyt said. But he added: “This is certainly a cautionary flag. This is a risk that we have been aware of for a while and have pointed out that it is one that we need to follow very closely, but I don’t know if it says we are going into recession.”

He said the trend to watch is not the increase in the inventory sales ratio – it has been too low – but the rate at which it increases and how much it begins to surpass pre-pandemic levels. Right now, “we’re not too far from desirable levels,” she said.

None of this can rule out the fact that Walmart was far out – caught with 32% more inventory year over year.

“It’s crazy,” former Walmart president and CEO Bill Simon told CNBC last week. I mean, 8% would have been high, 15% would have been terrible, 32% is apocalyptic. I mean, that’s billions of dollars worth of inventory. Frankly, it wasn’t handled very well. “

The goal was 43% higher.

“I think they were ordering to try to keep up with the supply chain problems and then the product came and arrived late and they didn’t cut orders in time, I mean there was a lot of things they could have, it should have, would have been done which frankly it wasn’t, “Simon told CNBC.

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

The hinge on goods-to-service spending and the sensitivity of retailers to low- and middle-income households who feel disproportionately the price squeeze in things like gas are real and acute issues. “People buy their luggage instead of the things they used to buy, so all the things that benefited retailers, alleviating the misery of quarantines, are now reversing, “Swonk said.” Most of the inflation is in the service sector, as is most part of the expense, and should slow the goods. The goods had seen deflation until the pandemic, “he said.

But while this may help the Fed get some drop in asset prices, it won’t cool the economy enough.

In the rapid development of inventories at large retailers, Swonk sees an inflationary economy perpetuating multiple booms and dips within it, and that shouldn’t allay concerns about the macro environment. “The Fed is in a world that is more boom-busting now,” Swonk said. “It’s like the Fed has gone through the looking glass and isn’t able, like Alice, to wake up. It’s still in an alternate universe and won’t come back,” he said.

The resilience of the US economy could ultimately raise the stakes on the Fed to raise rates.

“We generated 2.1 million jobs in the first four months of the year. This is one year [of job gains] on average in the 2010s and many new salaries, “Swonk said. well, taking profit margins based on high costs even as they pass on the price increases to consumers.

“This is what happens,” he said.

The whip that Walmart and Target experienced didn’t come out of nowhere and it’s not limited to the goods – Amazon understaffed when the world came out of omicron, a work factor also pointed out by Walmart in its recent earnings disappointment.

“These are clearly major retailers and it is important,” said Swonk.

Businesses will still be in a “we don’t know if we can get goods now” mentality, with “Zero Covid” lockouts still a problem in China, and that will hit small and medium-sized businesses even harder than it will hit retail giants. , who will make their own discounts. The major retail giants can better absorb the margin shock, but being hit by high inventory and costs still adds one thing for them: “Take it on the chin,” Swonk said.

Supply chain vulnerabilities aren’t disappearing, and building a pillow is expensive. “It’s been a long time since we last had something like this,” Swonk said.

What the market knows for sure from the recent spate of retail disappointments is that the shift from goods to services is underground and inflation hurts low-income households first and this begins to reduce corporate margins. But where does that close end?

This is the question Swonk says that a market already in crisis will have to answer.

The optimistic narrative has been that the economy can achieve this soft landing with the Fed’s “blunt” tools and sluggish demand in a world limited by unhindered supply in the way.

“That narrative is gone,” Swonk said. “The bumps are already there, and even if parts of the economy are benefiting from them.”

Resorts are sold out for the summer and airlines are back after nearly bankruptcy, and the move to services is a major shift, but also a reality check for the economy.

Stock market investors don’t care about margin pressures faced by independent restaurateurs, but when it manifests in the country’s major retailers, investors start worrying about where else they will see margin pressure. “It’s a blow to the mole,” Swonk said. “And you will see it elsewhere.”

Inflation is now as important a problem for businesses as it is for families, and that can change in an instant. “It has changed in their favor for a while, but the reality is that inflation burns everyone,” she said.

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

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