by Alex Harding, CFA
Vice President Equity Research
After one of the most aggressive tightening cycles in Federal Reserve history, we are beginning to see signs of a slowing economy and more mixed messaging from corporate America. While counterintuitive, stocks have rallied over 10% from their October lows as inflation looks to have peaked and third quarter earnings have come in better than feared. Despite this, companies revealed their weakest profit growth since the COVID-19 pandemic began as cost pressures are impacting bottom lines. Eight months into the Fed’s hiking campaign, one could argue the long and variable lags of monetary policy are starting to impact the economy.
Coincidentally, nominal retail sales data from the U.S. Census Bureau and corporate earnings results of blue-chip retailers such as Home Depot, Target and Walmart were reported this week. Stagnant retail sales in September rose sharply in October, advancing 1.3% month-over-month, indicating that consumer spending refuses to buckle under the weight of higher interest rates. While the headline number was positive, the details are a bit more nuanced with consumers shifting more of their dollars towards higher-priced staple products and away from discretionary goods such as electronics and apparel.
Source: U.S. Census Bureau
Earnings results from retailers this week confirmed many of the details found within the retail sales report. The world’s largest home improvement company, Home Depot, saw big-ticket item sales grow by 10%, offsetting the slowdown in overall transactions. The rapid rise in mortgage rates is increasing demand for home renovation projects as customers are reluctant or unable to move homes given affordability concerns. On the same day, Walmart announced better-than-estimated profits driven by increased store traffic and higher sales within their largest segment, grocery, as customer spending continues to shift towards essential products. In contrast, Target, which generates most of its revenue from discretionary items, missed earnings estimates by a wide margin and guided down profit forecasts. On the earnings call, the company’s CEO, Brian Cornell, spoke about the recent shift they’ve witnessed in consumer spending.
“So, what we've seen overall is a change in consumer behavior over the last few weeks. We're going to watch it carefully throughout the holiday season, but I think it is a byproduct of a consumer who has been facing higher costs throughout the year, is working with their budget, shopping very carefully, looking for value and recognize they've got to start with core staples before they spend dollars in discretionary categories. “
Unlike last year, consumers, who remain well-employed, will be pleased to find increased promotional activity and deeper discounts as they shop this holiday season. The reason why? Supply chain issues have abated and spending behavior has shifted, creating a glut of discretionary goods within retail inventories. While shoppers can rejoice knowing many holiday items will be lower in price, overall price levels remain too elevated and will likely keep the Fed’s foot firmly on the brakes of our economy.
Takeaways for the Week
Weekly unemployment claims remain stubbornly low, declining to 222,000 this week.
More “good news” in the labor market means more “bad news” for short-term interest rates.
While spending remains robust, the disparity between retailers’ earnings highlights the impact inflation has on consumption behavior.