What retail inventory misses, markdowns say about fighting inflation

Retailers are missing and missing big. It started last week with the Walmart and Target results which showed big inventory builds and the need for markdowns, and it’s been followed up by weak earnings and outlook from Abercrombie & Fitch which sent its shares tumbling in a similar fashion to what the big box retailers experienced.

Is retail the canary in the coal mine for the market? There’s good reason to pose the question, though it remains harder right now to answer it in the affirmative. Let’s start with the best-case scenario: the consumer is shifting in their spending habits from goods to services, and while the retailers got caught with the tide going out on their pandemic strength, the recent string of results are not the sign of a weakened consumer — it’s the preferences that are changing. Remember, no matter how much lower-income Americans struggle with inflation — trading down in grocery store shelves from premium to private-label and steak to ham, a shift that Walmart indicated was happening — two-thirds of consumer spending is done by one-third of Americans in the higher income brackets.

The Walmart and Target results could reflect the changing financial realities for mid- to lower-income households in the face of still high inflation, says Kathy Bostjancic, chief U.S. economist at Oxford Economics. And conversely, higher-income households are less affected by the inflation headwinds, and even if they feel some negative wealth effect, their balance sheets are still in very good shape.

“The level of their wealth and pandemic-fueled savings will continue to buttress their strong consumer spending, especially as they continue to shift towards more in-person services spending,” she said, and while the rotation of consumer purchases away from goods towards more services hurts retailers like Walmart and Target in sales volumes, it isn’t the economy’s loss as a whole.

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

“My knee-jerk reaction is recession can be avoided,” said Scott Hoyt, senior director for Moody’s Analytics. “The high-end consumer is more meaningful.”

Best Buy said on Tuesday its outlook has weakened but it isn’t planning for a “full recession.”

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

The stock market drop will weigh on sentiment and high-end consumers have historically been sensitive to it, but this is a unique environment with excess savings, especially among older consumers who were putting away much more cash in recent years as the pandemic created a hole in their spending, Hoyt said. “That doesn’t lessen my concerns about people at the low-end, but from an economics perspective, the high-end is more important, especially if there are still jobs. … If low-end…