Can’t figure out the economy? Walmart, Home Depot are having trouble too

If you think the economy is confusing right now, consider how baffling Home Depot and Walmart must be finding it.

Last week, two big retailers sent out cautionary signals about the health of the American consumer. In brief: Walmart said U.S. consumer spending started the year strong, but it expects to return home through the year, with weaker fiscal 2024 U.S. sales growth of 2 to 2.5 percent. Home Depot said consumer spending is rising, but it expects an overall sales-growth year with declining profits.

Indeed, the latest inflation reading from last Friday’s core personal consumption expenditure index was warmer than expected, showing a consumer showing that defied expectations. Friday’s PCE showed consumer spending rose more than expected as prices rose, rising 1.8% for the month compared to estimates of 1.4%.

From dwindling big-box retail earnings to expectations that deflation will be a straight line in 2023, the latest news from the markets and the economy highlights just how difficult the Federal Reserve has to cool the economy without a recession.

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

Consumer, retail stocks post very bad week

The 2023 outlooks from these two major consumer companies sent the Dow and S&P 500 down on Tuesday, and the market’s recent declines continued through the end of the week. It was not a good week for retail or consumer stocks either. The SPDR S&P Retail ETF is up 9% for the year but was down nearly 7% last week, its worst five-day stretch since July 2022. Consumer discretionary stocks turned in the worst performance of any S&P 500 sector, down close to 4.5% for the week.

Consumer well-being has been a question under the markets’ debate about inflation, as investors wonder whether households lost 6.4% of their inflation-adjusted disposable income last year — up 8% over the past two years. % increased thanks to COVID relief programs – will keep spending. January’s relatively high inflation boosted market sentiment from a recent rip-roaring report on retail sales, leaving investors and even top stores with divergent views on what comes next.

At a macro level, January retail sales rose 3% more than December’s decline and rose 6.4% from a year earlier, basically matching inflation. The University of Michigan’s consumer sentiment index has risen since November, and its latest reading last Friday delivered a confidence boost for the third-straight month, leading to a 12% improvement in consumers’ outlook on the economy for the coming year . A survey by rival conference board Consumer Conference said Americans thought the situation was improving in January but expected a recession later this year.

big-box store scene of spending

Walmart has been able to increase sales by expanding its grocery business, but those sales are less profitable than in general merchandise categories where consumer spending is declining or shrinking. It’s compensating through investing in more efficient operations, and boosting its online unit’s higher-margin advertising business.

“Attempting to predict with accuracy swings in macroeconomic conditions and their impact on consumer behavior is challenging,” John Rainey, Walmart’s chief financial officer, told analysts on the company’s recent earnings call. “Thus, our guidance reflects a cautious outlook on the macro environment.”

Home Depot expects higher home equity to spur consumer demand, at least for a while, before pressure from inflation and interest rates kick in. Sales of existing homes posted their twelfth-straight monthly decline in January, but the slow pace of the decline has given rise to some optimism that the housing market may be nearing bottom.

Home Depot CEO Ted Decker told analysts on a recent earnings call, “We still see a healthy customer base. We have good jobs, job growth, rising wages, still strong balance sheet.” “We see a unique environment right now with many cross currents. Obviously there is inflation and rising interest rates, tight labor markets and moderate equity and housing markets. So taking all of these into account, we expect home improvement demand to improve. We do.”

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

Among Wall Street firms, economists at Goldman Sachs believe the consumer power may continue, saying household income growth bottoms out in 2022 as Covid-related income support programs expire, and this year Companies including Walmart in particular will get strengthened. Goldman economists expect disposable personal income to rise 6.1% this year compared to a 0.4% decline in 2022, according to a recent report, driven by rising wages and higher benefits for small business owners. This means consumers can spend more without dipping into savings and investment gains.

“Sustained consumer spending growth remains the outlook,” wrote consumer analyst Jason English. “grow thin [disposable income] And the reduction in required spending inflation means that spending growth will not need to be financed from net savings. [a] Return to savings rate expected in the first quarter of 2023.”

Friday’s PCE report showed that the personal savings rate rose to 4.7%.

house prices, groceries, inflation

At Morgan Stanley, retail analyst Shimon Gutman described what he saw as a marked difference in the outlook for the two big retailers after last week’s earnings release. His Take: Home Depot’s clientele is more affluent than Walmart’s, especially from the home equity gains of recent years. But Home Depot’s approach to the coming drop in home prices may be a complete failure, he suggested.

“WMT’s more serious consumer outlook is undoubtedly informed by the weakness seen in general merchandise and the overall mix shift [groceries, which are less profitable]”HD’s more balanced approach could mitigate the effects of a sharp downturn in housing metrics,” Gutman said.

There may be a simple way to untangle the conflicting signals on consumer and retail numbers, said Richard Moody, chief economist at Birmingham-based bank holding company Region Financial. Walmart may soon see an impact from inflation, which will continue to slow in the second half of the year.

“The cumulative effects of higher inflation will take a toll, and the slowing of labor income growth will also put pressure on spending,” Moody’s said. “Remember, even if inflation slows down, prices are still going up, they’re going up at a slower rate, so less inflation won’t give consumers a bunch of cash to spend.”

But Home Depot could benefit from a drop in 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.

Fed interest rate forecast

Predicting where rates will end up in 2023, however, is no easy task. The year began with the bond market believing the Fed was nearing the end of rate hikes and growing more likely that the Fed would cut before the end of the year as inflation slowed and began to look more likely. The economy will achieve a “soft landing”. But after two straight warmer-than-expected consumer inflation readings in recent weeks from the CPI and PCE, there is now talk of a potentially 50 basis point hike at the Fed’s next meeting, and a “prolonged high” view where Rates end the year (above 5%) among Fed watchers who are suddenly back in the driver’s seat.

Gutman said gains from next week’s earnings reports by retailers such as Costco and Target suggest there is upside to stocks such as Walmart if consumers prove healthier than the company’s guidance. And the minutes of the Fed’s January meeting rattled off an idea that markets haven’t focused on yet: that states, which have doubled the size of their rainy day funds since 2018, Money cut in taxes could give consumers the money, partly by hanging on to some Covid-driven federal aid.

,[P]Participants noted that inflation was eroding the purchasing power of households,” the minutes reported. “However, a couple of participants noted that some states pass part of their large budget surpluses to households through tax cuts or exemptions. Can return, which will support consumption. ,