With most U.S. economic activity emanating from the consumer, this week’s most crucial economic release is October retail sales on Tuesday. The headline reading should be a robust 1.3% increase but is likely “inflated” by gasoline station sales which are boosted by the 6.1% rise in gas prices. Removing the auto and gas sales leaves an expected 0.7% growth rate, the same as September. Like most economic measures, the analysis is complicated by Covid and the policy response to the pandemic. Due to continuing supply chain issues, there are upside risks to retail sales with a possible pull-forward of holiday spending. Still, inventory constraints will limit the extent of early buying.
Though third-quarter earnings season is winding down, this week has many retailers reporting, including Walmart (WMT), Target (TGT), Home Depot (HD), Lowe’s (LOW), Kohl’s (KSS), TJX Companies (TJX), Macy’s (M), and Ross Stores (ROST). The macroeconomic backdrop of significant consumer demand and healthy household balance sheets should provide a substantial tailwind for the retailers.
Online shopping levels have normalized somewhat, with in-person shopping benefitting. This shift has already shown up in the profits for some primarily offline retailers. Traditional department store, Dillard’s (DDS), posted another significant earnings beat this quarter after a massive beat in the previous quarter. Sales at Dillard’s in the quarter were higher than the same quarter in pre-pandemic 2019.
Earnings from the retailers this week should have primarily upside risk. Accelerated holiday spending, credit card data, and color from other retailers reinforce the positive story. Inventory shortages and cost increases should constrain the upside surprises somewhat but are likely to be overwhelmed by consumer demand. Most of the stocks have run up substantially since the end of September, so the earnings outperformance will probably need to be substantial to fuel additional gains. The other items to watch will be how much demand is pulled forward into this quarter and subtracted from the traditionally strongest holiday quarter. Additionally, shipping costs and lack of inventory continue to be a challenge. There seems to be some improvement on the shipping front, with freight rates from China to L.A. falling from the recent peak.
While the markets have cheered the earnings rebound for some traditional retailers, it will be essential to distinguish between a temporary boost from reopening and a durable ability to compete with the secular transition to e-commerce continuing. Among the items to watch for traditional retailers will be the success of their online efforts. Omnichannel distribution, embracing beauty products, and athleisure reinforcing store traffic will be crucial to the long-term viability of most brick-and-mortar retailers.
While the U.S. has seen a significant decrease in the pace of Covid infections since the September peak, the rate of change moved a bit higher last week. Unfortunately, Europe is continuing to see a pickup in the pace of infections.
Consumer inflation (CPI) grew at a three-decade high of 6.2% year-over-year in October. While inflation should moderate as the supply chain disruptions ease, October CPI added fuel to the fire of worries that the rise in prices will be more permanent. First, the relatively good news, supply chain disruptions are still impacting pricing, with used cars and auto rental costs being the most straightforward example. These prices should normalize once auto production is restored.
Commodity prices have continued their march higher and have risen at a 14.3% annualized pace since the end of 2019. This increase in gas, food, and other input prices has helped fuel the 3.8% annualized rise in the CPI during the same period.
The more troublesome aspect of the increase in inflation is seeping into the more permanent areas of pricing. Rising housing prices, which are favorable for homeowners’ balance sheets, are a leading indicator of rent increases. Rent costs tend to be very sticky and rarely decline.
The Atlanta Fed’s Sticky CPI has done an excellent job of cutting through the noise in the past and reflects the underlying inflation rate now above 3%.
The bond market reacted swiftly to the CPI, with the yield on two-year U.S. Treasuries rising almost ten basis points (0.10%) on Wednesday after the report. This yield spike was the sharpest daily move since March 2020. Treasury Inflation-Protected Securities (TIPS) ten-year breakevens, which measures the inflation expectations priced into the bonds, surged to 2.72% last week, a level not seen since 2006. It is too early to declare inflation out of control, but it will remain a factor worth watching closely. The combination of good economic growth and higher inflation is palatable to markets, but a sniff of stagflation would not be received well.