Throughout the year, we have been noting that consumer incomes were likely going to slow as a result of the fiscal support from 2021 not being repeated in 2022, and more recently, price increases in areas like gasoline and food reducing purchasing power for discretionary items. Last week, the retail team at research firm Hedgeye Risk Management went over examples of how the above-mentioned trend is negatively impacting the apparel space, which we think could have implications for the broader economy.
In prior updates, we have noted that consumer spending has been decelerating, especially on a real/inflation adjusted basis. The categories that have been growing are gasoline stations, food service and drinking places (bars and restaurants), and food and beverage stores (grocery and convenience stores). These categories were responsible for 75% of the year-over-year increase in May, with 50% being grocery and gasoline stations.
The increase in these categories is largely a function of higher commodity prices, not demand/unit growth. Since these are necessities with no real substitutes, cost increases pull spending power away from discretionary categories. Removing food, gas station, and auto sales (largest category but not a recurring purchase) shows that year-over-year growth has declined significantly for the other categories (especially since the commodity spike following the Russian invasion).
This decline in discretionary spending and sales are occurring at a time when inventories have been rising and are still increasing at a pace above 2019-2021.
Not only are inventories building, but the cost of these inventories have also been accelerating, as producer prices for apparel continues to accelerate.
Rising costs at a time of falling sales typically leads to declining profit margins. This will likely be a common topic of discussion during the upcoming second quarter earnings season. If the impact to margins is severe or sustained, it could lead to increased cost cutting, some of which could be layoffs. This is something we are continuing to monitor through metrics like initial jobless claims.
While this analysis focused specifically on the apparel component of the retail sector, we believe this phenomenon of falling sales, rising inventories/costs, and declining margins is likely taking place across multiple parts of the economy. If this turns out to be the case, it could lead to cost reductions in the form of a broad-based increase in layoffs.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC