Don’t understand economics? Walmart and Home Depot also have problems

If you think the economy is confusing right now, consider how confusing it must look for Home Depot and Walmart.

Last week, the two major retailers sent cautious signals about the health of the American consumer. In a nutshell: Walmart said U.S. consumer spending started the year strong, but expects households to pull back throughout the year, producing weak growth in sales in the United States for the 2024 fiscal year from 2 to 2.5%. The Home Depot said consumer spending is holding up, but it expects a year of flat sales growth overall, with declining profits.

Indeed, last Friday’s latest core personal consumption expenditure index inflation reading was higher than expected, showing a consumer who continues to defy expectations. Friday’s PCE showed consumer spending rose more than expected as prices rose, jumping 1.8% for the month from the 1.4% estimate.

From big box retail profits to dwindling hopes that disinflation would be a straight line in 2023, the latest market and economic news shows how the Federal Reserve is struggling to cool the economy without causing a recession.

“The consumer is resilient right now,” said CFRA Research analyst Arun Sundaram. “The consumer is still spending, not as much as a year or two ago, but it hasn’t quite stopped.”

Consumer and retail stocks have a very bad week

The 2023 outlook for these two major consumer companies dragged the Dow Jones and S&P 500 down on Tuesday, and the market’s recent losing streak continued through the end of the week. It was also not a good week for the retail sector or consumer stocks. The SPDR S&P Retail ETF is up 9% for the year, but was down about 7% last week, its worst five-day period since July 2022. Consumer discretionary stocks posted the worst performance of all S&P 500 sectors, down nearly 4.5. % for the week.

Getting a good read on the consumer has been an underlying issue in the markets debate over inflation, as investors wonder whether households that last year lost 6.4% of their inflation-adjusted disposable income Inflation – which has risen more than 8% in the previous two years, thanks to Covid relief programs – will continue to spend. Relatively high inflation in January offset the boost in market sentiment following a recent searing retail sales report, leaving investors, and even department stores, with differing views on what comes next.

At the macro level, January’s retail sales increase of 3% more than reversed the decline in December and, up 6.4% from a year ago, was essentially in line with inflation. The University of Michigan’s Consumer Confidence Index has risen since November, and its latest reading last Friday showed renewed confidence for the third month in a row, led by a 12% improvement in consumer outlook on the savings for the coming year. The Conference Board’s concurrent consumer conference survey says Americans thought conditions were improving in January, but expect a recession later this year.

The view of big-box store spending

Walmart has been able to maintain sales growth by expanding its grocery business, but those sales are less profitable than general merchandise categories where consumer spending is leveling off or declining. It compensates by investing in more efficient operations and boosting its online unit’s high-margin advertising business.

“Trying to accurately predict fluctuations in macroeconomic conditions and their effect on consumer behavior is a challenge,” Walmart chief financial officer John Rainey told analysts on the company’s recent earnings call. “As such, our forecast reflects a cautious outlook on the macro environment.”

Home Depot expects high home equity to support consumer demand at least for a while, before inflation and interest rate pressures tighten further. Existing home sales posted their twelfth straight monthly decline in January, but a slower pace of decline has led to some optimism that the housing market may be close to bottoming.

“We also still see a healthy customer. We have good jobs, job growth, rising wages, still strong balance sheets,” Home Depot CEO Ted Decker told analysts during the call. its recent earnings call. “We see a unique environment with many cross-currents at the moment. Obviously, there is increased inflation and rising interest rates, a tight labor market and moderating equity and housing markets. So given all of that, we expect home improvement demand to moderate.”

Home Depot was the second worst performing stock in the Dow last week, down nearly 7% – the only Dow stock that did worse was Intel, which cut its dividend by 65%.

Among Wall Street firms, Goldman Sachs economists believe consumer strength can continue, saying household income growth bottomed out in 2022 with the end of Covid-related income support programs, and will rebound this year, strengthening companies, including Walmart in particular. Goldman economists expect personal disposable income to rise 6.1% this year, from a 0.4% drop in 2022, according to a recent report, driven by rising wages and higher profits for small business owners. This means consumers can spend more without dipping into savings and investment gains.

“The prospect of sustained growth in consumer spending remains,” wrote consumer analyst Jason English. “Growth (in disposable income) and moderation in essential spending inflation means that spending growth will no longer need to be financed by net savings, with (a) a rebound in the savings rate expected from the first quarter of 2023.”

Friday’s PCE report showed the personal savings rate was up, hitting 4.7%.

House prices, groceries, inflation

At Morgan Stanley, retail analyst Simeon Gutman described what he saw as a notable difference in the outlook for the two big retailers after last week’s earnings. His take: Home Depot’s customer is wealthier than Walmart’s, buoyed in part by gains in home equity in recent years. But Home Depot’s view may not fully account for upcoming declines in home prices, he suggested.

“WMT’s more disappointing consumer outlook is no doubt informed by the weakness it has seen in general merchandise and the overall mix shift toward (groceries, which is less profitable),” Gutman said. “HD’s more balanced view may underestimate the lagging impact of a rapid deceleration in housing metrics.”

There may be a simple way to reconcile the mixed signals between consumer and retail figures, said Richard Moody, chief economist at Birmingham-based bank holding company Regions Financial. Walmart could see an earlier impact from inflation, which will continue, albeit at a slower pace, in the second half of the year.

“The cumulative effects of high inflation will have knock-on effects, and a slower pace of labor income growth will also weigh on spending,” Moody said. “Remember that even though inflation is slowing, prices are still going up, they’re just going up at a slower rate, so lower inflation won’t free up a lot of money for consumers to spend.”

But Home Depot could benefit from lower interest rates in late 2023, producing a modest but steady rate of growth in line with the bank’s outlook for the single-family housing market, he said.

Fed, interest rate forecast

However, predicting where rates will end in 2023 is no easy task. This year started with the bond market convinced that the Fed was nearing the end of rate hikes and increased its chances that the Fed would cut before the end of the year as inflation slowed and it started to look more likely. that the economy has achieved a “soft landing”. But after two consecutive warmer-than-expected consumer inflation readings in recent weeks from the CPI and PCE, there is now talk of the Fed possibly raising 50 basis points at the next meeting, and the “higher for longer” view of end of rates. the year (more than 5%) is suddenly back in the driver’s seat among Fed watchers.

The upshot, in earnings reports from retailers like Costco and Target next week, is that there’s a rise in stocks like Walmart if consumers turn out to be healthier than one’s guidance suggests. either of the companies, Gutman said. And the minutes of the Fed’s January meeting launched an idea markets have yet to focus on: that states, which have doubled the size of their rainy-day funds since 2018 in part by clinging to some Covid-focused federal aid, could give consumers the money by cutting taxes.

“The (P)participants noted that inflation was eroding household purchasing power,” the minutes report. “However, a few participants noted that some states could return some of their large fiscal surpluses to households through tax cuts or refunds, which would support consumption.”