Zooming Out

Barron's Teresa Rivas has been covering this week's retail earnings reports, and she has some big-picture lessons to share.

Although consumer spending remains strong , as Review & Preview covered last night, that's not the end of the story. People are being forced to spend more on necessities due to inflation, and that's taking a bite out of demand for more discretionary purchases. And the post-pandemic reopening of the economy is giving consumers more options to spend on experiences after two years of elevated spending on goods.

“In the short term it’s not good because the consumer is shifting their focus from big-ticket items or splurges to staples,” Kovitz Investment Group portfolio manager John Buckingham told Teresa. “There is still the desire for experiences, but Target and Walmart don’t offer experiences, so you’re going to have a struggle here as the consumer rejiggers near-term.”

Teresa also notes that not all consumers are created equal. The substitution of demand away from discretionary purchases due to the inflation squeeze is largely hitting lower-income consumers who are more price sensitive. It is being seen more in the demand for the kind of mass-market, lower sticker-price products that tend to appeal to less-affluent shoppers.

Teresa continues:

[Another] takeaway is that while that pullback may not be a surprise to anyone who was suddenly spending much more to fill up their tanks, it did catch management teams by surprise. Walmart was taken aback by the magnitude of issues like inflation and freight costs. Target offered a similar mea culpa, noting on its conference call that transportation costs were much higher and the shift in consumer category spending was more dramatic than they anticipated.

“Overall, we were caught off guard by Target’s rapid change in outlook and worry that we could see more downward revisions to guidance, especially if overall consumer spending weakens and the U.S. economy moves closer to a recession,” writes CFRA’s Arun Sundaram, who downgraded Target to Hold from Buy on the news.

That helps explain why Target's pain spread across the retail sector and the broader market. It was a reminder that, these days, the situation on the ground is changing quickly, and it's not always so obvious to the folks at the top what the right next move is.

Pair that pessimistic takeaway with already shaky investor sentiment, and you have a selloff like today's.

Read more of Teresa's thoughts on the past week of retailer earnings here.

 

By the way, retailers' reports are clustered at the end of every earnings season, because they tend to follow a fiscal year that's shifted by a month. A major portion of their annual sales come during the holiday season, and rushing to prepare financial statements in late December and early January would be a challenge. So many retailers opt to have a fiscal year that ends in January. Thus, the fiscal first-quarter reports out this past week have been for the months of February, March, and April.