THE DAILY EDGE: 18 MAY 2022: Retail Warnings!

RETAIL SALES: PICK YOUR NUMBERS

Inflation is tricking retail sales data. There is no official deflator for retail sales. The St-Louis Fed provides a Real Retail Sales Series but it simply uses total CPI as a deflator. Most of the time, this is a valid proxy. This year, however, it is misleading because services inflation, 60% of the CPI, is much lower than goods inflation. There are virtually no services in retail sales data. Deflating with total CPI therefore currently overstates real sales.

This chart plots CPI-services (red, +5.4% YoY in April) with CPI-durables (blue, +14%), CPI-nondurables (yellow, +12.8%) and my own CPI-retail (black, +12.5%), essentially using a CPI-ex-services calculation. This provides a much better reflection of retail price trends since mid-2020. By comparison, total CPI was up 8.3% in April.

This next chart shows the YoY trends in nominal retail sales (red, +8.2% in April), real retail sales per the St-Louis Fed (blue,-0.03%) and my own version of real sales (black, -3.8%).

This other chart plots the same series indexed at February 2020 = 100. Nominal sales remain in an uptrend, up a huge 28.8% from their pre-pandemic level. The St-Louis Fed version of real sales has flattened since March 2021 and is up 15.6% while my own version of real sales has been trending down and is up a lesser 10% from its pre-pandemic level. Importantly, it’s back on its long-term trend (dash), meaning that Americans’ splurge on goods is over.

Americans generally spend their labor income (aggregate payrolls in black below). During the pandemic, particularly since March 2021 (remember the stimmies), they spent much more, significantly overspending on goods which propelled retail sales. The latest data suggest that payrolls are back as the main driver and that savings may not play as big a role as many expect in 2022.

Now we can better understand the “surprising” poor results from some of the best retailers in the world.

Walmart Flashes a Warning Sign to the Entire Consumer Economy The world’s biggest retailer is known for being careful about costs. But that’s harder to do when prices for everything are going up.

The country’s largest retailer by revenue said sales increased in the most recent quarter, but higher product, supply-chain and employee costs ate into profits, sending the retailer’s stock sharply lower Tuesday. (…)

On Tuesday Walmart said its net income in the April-ended quarter fell 25% from a year ago, and that earnings per share came in below analysts’ forecasts. (…)

“We’re not happy with the profit performance for the quarter and we’ve taken action, especially in the latter part of the quarter on cost negotiations, staffing levels and pricing, while also managing our price gaps,” Mr. McMillon said on Tuesday.

Inventory levels increased over 33% in the quarter from the same period last year. That rise reflects the higher cost of goods due to inflation, the company said, along with Walmart’s choice to buy products aggressively amid supply-chain snarls and rising demand for some goods in past quarters. Product markdowns, when a retailer sells an item at a discount, were $100 million more than expected in the quarter.

Supply-chain costs also came in higher than expected as the war in Ukraine and uptick in Covid-19 globally created delays, said Chief Financial Officer Brett Biggs. “The supply chain didn’t move towards normal as quickly as we thought,” he said. (…)

U.S. comparable sales, those from stores or digital channels operating for at least 12 months, rose 3% in the quarter ended April 29 (…).

Walmart said it expects U.S. comparable sales for the full year to grow about 3.5%, up from a prior estimate of 3%. It expects operating income to decrease about 1%, excluding currency fluctuations, down from a previous estimate of an around 3% increase. (…)

If Walmart is struggling even with its thriftiness and superior scale, then smaller and less efficient retailers are in for a very difficult time — not least because there was another note of caution in Walmart’s first quarter announcement.

The squeeze of inflation on discretionary incomes is starting to affect what consumers buy. Because Americans were having to spend more on food, they cut back on clothing and home furnishings more than Walmart had expected. Unseasonably cool weather, affecting items such as apparel and patio furniture, didn’t help either.

Walmart isn’t the only retailer to feel the pinch of high prices. While Home Depot Inc. reported better-than-expected first-quarter sales and saw an 11% increase in the average amount that each consumer spent in the first quarter, the number of customer transactions fell by 8%. (…)

• Target Stock Sinks 20% on Earnings Miss, High Costs Retailer posts profit trailing Wall Street forecasts as shoppers buy fewer TVs and kitchen items.

(…) Comparable sales, including sales from Target stores or digital channels operating for at least 12 months, rose 3.3% from the prior year, the company said. Digital sales climbed 3.2%—its slowest growth since the beginning of the pandemic.

While total revenue increased 4% to $25.2 billion, operating income was $1.3 billion, down from $2.4 billion for the same quarter in 2021. Target reported earnings per share of $2.16, down 48% from a year earlier, and below Wall Street forecasts. (…)

Target’s operating income margin rate was 5.3%, compared with 9.8% in 2021, with the retailer saying it expected a similar level of profitability in its second quarter. For the full year, the company said it continues to expect an operating margin rate in a range centered around 6%. (…)

Target management said fuel and freight costs will be $1 billion higher this year than it had expected, with little sign of their easing throughout 2022. The company said it would try not to pass those cost increases to consumers through higher prices for its goods, trading short-term profit for what it hopes will be longer-term market-share gains. (…)

“Throughout the quarter, we faced unexpectedly high costs, driven by a number of factors, resulting in profitability that came in well below our expectations, and well below where we expect to operate over time,” Target Chief Executive Brian Cornell told reporters. (…)

“These (costs) continue to grow almost on a daily basis and there is no sign right now…that it is going to abate over time.”

Mr. Cornell said customers were buying fewer big items such as bicycles, TVs and kitchen items than in the past two years. Shoppers are “moving from buying small kitchen appliances and maybe replacing that with gift cards to restaurants and entertainment as they return to a more normalized lifestyle,” he said. (…)

“(Pricing) continues to be the last lever we pull,” finance chief Michael Fiddelke said. “While we don’t like the impact to our profitability in the short term, we know it is the right thing to do.” (…)

• Lowe’s sales disappoint as late spring hurts seasonal demand Same-store sales decreased 4% in the first quarter ended April 29, compared with Wall Street expectation of a 2.5% fall.

Contrast these comp sales growth rates in the 3% range (even drops like at Lowe’s) with total CPI up 8.3% in April, let alone of my own CPI-retail at +12.5% in April.

These are HUGE declines in volume, resulting in excess inventories (+33% at WMT!!!) that will lead to more markdowns, cancelled orders and weakening manufacturing activity worldwide.

Pricing power has disappeared!!!

Payrolls are currently rising faster than inflation thanks to rising employment and wages but the gap is narrowing. The Fed needs to slow employment growth to prevent a wage spiral. The hope is that inflation will slow in sync, protecting real income. This is the recipe for a soft landing: don’t squeeze the consumer.

Mr. Powell is well aware of the challenging odds. We should all be:

• Powell Says Fed Has Resolve to Bring U.S. Inflation Down Central bank chief voices confidence in ability to curb rising prices without triggering recession but notes challenges ahead

(…) “Restoring price stability is an unconditional need. It is something we have to do,” Mr. Powell said in an interview Tuesday during The Wall Street Journal’s Future of Everything Festival. “There could be some pain involved.”

Mr. Powell said he hoped that the Fed could bring down inflation while preserving a strong labor market, which he said might lead the unemployment rate—near half-century lows of 3.6% in April—to rise slightly. “It may not be a perfect labor market,” he said. (…)

Mr. Powell said Tuesday that it was possible that disruptions from the pandemic had changed the labor market in ways that made current levels of unemployment inconsistent with the Fed’s 2% inflation goal.

He said that it seemed the unemployment rate consistent with stable inflation “is probably well above 3.6%.” (…)

The Fed chairman repeated his hope that the central bank can curtail high inflation without spurring a large rise in unemployment. However, Mr. Powell said, there is little from modern economic experience to suggest that outcome can be achieved. “If you look in the history book and find it—no, you can’t,” he said. “I think we are in a world of firsts.” (…)

“We will go until we feel like we are at a place where we can say, ‘Yes, financial conditions are at an appropriate place. We see inflation coming down,’” Mr. Powell said. “We will go to that point, and there will not be any hesitation about that.”

“This is not a time for tremendously nuanced readings of inflation,” Mr. Powell said. “We need to see inflation coming down in a convincing way. Until we do, we’ll keep going.”

Wells Fargo & Co. Chief Executive Charlie Scharf, speaking at the same event Tuesday morning, said it would be difficult to avoid a recession but noted that consumers and businesses remain financially solid.

“The fact that everyone is so strong going into this should hopefully provide a cushion such that whatever recession there is, if there is one, is short and not all that deep,” he said. (…)

Gasoline Tops $4 a Gallon in Every US State for the First Time

U.K. Inflation Hits 40-Year High The U.K.’s annual rate of inflation jumped to 9% in April, the highest level recorded by an industrialized nation since the start of the global price surge last year.

• British Consumers Are Finally Starting to Crack Consumer confidence in the UK is slumping, as higher bills for energy, fuel and groceries weigh on consumers.

(…) GfK’s measure of consumer confidence slumped to -38, a level last seen in the early 1990s as well as in 2008. Of particular note is the GfK index that tracks how people feel about making a major purchase: The most recent data suggest Brits don’t think this is a good time to buy expensive items such as furniture or cars. (…)

Sales weakened in April, according to the British Retail Consortium and KPMG’s Retail Sales Monitor. Although this figure compares with the period a year ago, when consumers were unleashing pent-up demand after stores reopened, it’s clear that spending is sliding. With total sales falling by 0.3% in April, and inflation estimated at 9.1% that month, this implies a big fall in the volume of goods sold. (…)

Big-ticket items were hit hardest by the slowdown in April, according to the BRC and KPMG. Many Brits refreshed their homes when they were spending much of their time there. Now, furniture sales are suffering. In addition, the sector is seeing price rises, because items are generally bulky and expensive to ship in containers. Made.com Group Plc, the online home-furnishings retailer, warned on profits on Monday after volatile trading, and estimated that the digital furniture market as a whole was down by 30% to 40% so far this year. (…)

Data from Barclaycard showed that consumer credit and debit-card spending rose 18.1% in April, compared with the corresponding period in 2019, marking the highest uplift since October 2021. However, this was largely driven by holiday bookings. International travel had its best month since before the outbreak of Covid-19. In contrast, spending on some other categories, such as nights out, takeaways and subscriptions all had smaller boosts than in March. (…)

U.S. Home Builder Index Took a Steep Drop in May

The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo fell 10.4% m/m (-16.9% y/y) to 69 in May from 77 in April. This is the fifth straight month that builder sentiment has declined and the lowest since June 2020. The decline was significantly steeper than the INFORMA Global Markets survey expectations of 76.

The current sales reading fell 9.3% m/m (-11.4% y/y) in May to 78 from April’s reading of 86 and stood at its lowest level since July 2020. The index of expected sales in the next six months dropped 13.7% m/m (-22.2% y/y) to 63 in May from 73 in April. The index peaked at 89 in November 2020.

The index measuring traffic of prospective buyers fell 14.8% m/m (-28.8% y/y) to 52. The index stood at the lowest level since June 2020.

Regional activity was largely weak in May. The NAHB reported that “growing affordability challenges in the form of rapidly rising interest rates, double-digit price increases for material costs and ongoing home price appreciation are taking a toll on buyer demand”. The index for the Midwest fell 17.7% m/m (-28.2% y/y) to 51. The index for the West declined 13.1% m/m (-19.8% y/y)) to 73. The South posted a decline of 7.3% m/m (11.6% y/y) to 76 in May. The Northeast was the only region posting a monthly rise, up 2.7% m/m (-2.6% y/y). These regional series begin in December 2004.

Demand has normalized. Traffic has dropped to levels that were on the high side pre-pandemic. The frenzy is gone. The froth will follow.

U.S. Industrial Production Much Stronger than Expected in April

Industrial production increased 1.1% (6.4% y/y) in April following an unrevised 0.9% gain in March. A 0.4% increase had been expected in the Action Economics Forecast Survey. Manufacturing output rose 0.8% m/m (5.8% y/y) in April, the same monthly increase as in March (revised down slightly from 0.9%). Utilities output increased 2.4% m/m (7.5% y/y) following a 0.3% decline in March. Mining output gained 1.6% m/m (8.6% y/y) in April after a 1.9% m/m increase in March.

The increase in manufacturing output in April was once again led by motor vehicle and parts production, which was up 3.9% m/m on top of an upwardly revised 8.4% monthly gain in March (initially 7.8% m/m). Durable goods manufacturing was up 1.1% m/m while nondurable good output rose a more modest 0.3% m/m.

In the special classifications, factory output of selected high technology industries fell 0.3% m/m in April, the first monthly decline since August 2021, after a 1.4% m/m gain in March. Factory production excluding the high technology sector increased a solid 0.8% m/m, the same monthly increase as in March. Manufacturing production excluding both high tech and motor vehicles rose 0.6% m/m in April after a 0.3% m/m increase in March.

Capacity utilization rose to 79.0% in April, the highest level since December 2018, from 78.2% in March (revised from 78.3%). A 78.6% rate had been expected. Utilization in the factory sector rose to 79.2% in April, the highest reading since April 2007, from 78.6% in March (revised from 78.7%).

  

Canada Can Boost Oil Output by 900,000 Barrels a Day, Kenney Says

China’s New Home Prices Fall for the First Time in More Than Six Years A monthly measure of new home prices in China fell for the first time in more than six years, offering further evidence of the pain that Beijing’s regulatory campaign is inflicting on the sector.

Average new-home prices in 70 major cities edged 0.11% lower in April from a year earlier, according to Wall Street Journal calculations based on data released Wednesday by China’s National Bureau of Statistics.

The decline, though slight, marks the first such decrease since November 2015 when China was wrestling with a pronounced slowdown. It follows a 0.66% year-over-year increase in March.

When compared with the previous month, Chinese new-home prices declined for an eighth consecutive month, falling 0.3% in April—wider than March’s 0.07% month-to-month decrease.

New-home prices rose in just 30 of the 70 cities last month, compared with the 40 cities that saw increases in March. The declines were generally concentrated in China’s smaller and poorer cities, Sheng Guoqing, an analyst at the statistics bureau, said Wednesday. (…)

“Policies to stabilize home prices and buyers’ expectations need to be issued soon. Otherwise the prices will continue to cool.” (…)

As of Monday, full or partial lockdowns have been implemented in 38 Chinese cities, affecting 271 million people, according to analysts at Nomura, an investment bank. (…)

On Monday, China reported that new-home starts and home sales by value plunged 44% and 47%, respectively, in April from a year earlier.

Mortgage demand also plunged last month, contracting by the equivalent of $9 billion last month, China’s central bank said Friday. (…)

It’s not only new homes:

The share of cities that experienced sequentially higher property prices dropped in April from March

Hmmm…

Source: Goldman Sachs Global Investment Research

Tencent Disappoints After Lockdowns, Crackdown Wipe Out Growth

Sales barely rose to 135.5 billion yuan ($20.1 billion) for the three months ended March, missing the average forecast, after online ad revenue plummeted 18%. Overall growth decelerated for a seventh straight quarter, to the slowest pace since the Shenzhen company went public in 2004. (…)

Net income slid 51% to 23.4 billion yuan, lagging estimates despite a big gain from the sale of stock in Singapore’s Sea Ltd. (…)

Stock Selloff Crunches SPAC Creators An investor stampede out of risky trades is squeezing special-purpose acquisition companies that are running out of time to find businesses to take public.

(…) Because so many SPACs raised money during the frenzy early last year, roughly 280 face deadlines in the first quarter of 2023, figures from data provider SPAC Research show. If the current pace of SPAC deal making continues, analysts estimate that a large percentage of those blank-check firms won’t find mergers. The merger window for many SPACs is closing because it often takes months to find a deal and many companies that previously might have considered such mergers are now electing to stay private, bankers say.

Creators of those SPACs and other insiders together are now expected by early next year to lose $1 billion or more—money known as “at-risk capital” that they have already spent setting up the SPACs and can never get back. (Of course, if the creators do strike deals, they stand to make several times their money on paper because of how those deals are structured.) (…)

Some investors expect many SPACs to pursue low-quality companies to take public at improper valuations to stave off possible losses. They say that possibility shows the incentive problems inherent in such deals. Even with that expected push, analysts say many SPACs won’t find mergers because there simply aren’t enough companies that will want to complete SPAC deals in time. (…)

The recent market collapse is already triggering some SPAC liquidations and throwing a wrench in deal negotiations, bankers say. It also comes as federal regulators are tightening rules on how blank-check companies make disclosures and business projections when taking companies public.

About 90% of the companies that completed SPAC mergers during the boom that started in 2020 now trade below the SPAC’s initial listing price, according to SPAC Research. (…)

• SPACs Are Sputtering. Desperate New Terms Could Send Them Into a Death Spiral.

(…) The stock prices bear out the analysis. More than 300 companies that have gone public via SPAC mergers since the start of 2018 have averaged a loss of about 33 percent from the IPO price of the SPAC, versus an average loss of 2 percent for the 1,000 other companies that chose to go public through a traditional IPO as of mid-April, according to Renaissance Capital, which tracks IPOs. Compared with the S&P 500, which gained more than 50 percent during that time, the SPAC numbers are little short of a disaster. (…)

SPAC investors who can vote for the merger deals but sell out on the announcements and get their money back are doing just that. Redemptions in 2020 averaged 80 percent and are now at about 90 percent, according to market sources. (…)

The rising level of redemptions leaves the funding for the merger deals almost entirely up to PIPEs. “The PIPEs are a foundational cornerstone of a successful SPAC deal. If you find institutions to validate the transaction and its valuation, then any other investors may choose to leverage that due diligence to get comfortable with committing capital to it,” explains Ben Kwasnick, founder of SPAC Research, which tracks the market.

But there isn’t enough money coming in from PIPE deals to fill the hole. This year, PIPEs have raised only about $2.8 billion, compared with almost $14 billion in the peak month of February 2021, according to data provider SPACInsider. Fidelity, which has done $32.2 billion in PIPE investments in the past three years, made its last one in October, and BlackRock, which committed $24 billion to PIPEs during the same time period, did its last in July. Those two firms account for more than 60 percent of the $88.1 billion of PIPE money that has been raised in the past three years, according to SPACInsider.

PIPE investors have also been losing money. (…)

But though the SEC’s hard line may help stem the flood of shoddy SPACs, it seems unlikely to solve the structural problems that beset the entire sector — which are getting even worse. (…)

In March 2021, when Cembalest looked at SPAC returns, he found that the sponsors had raked in a median 468 percent return since January 2019, even after accounting for all their concessions, forfeitures, and vesting. By August, that number had gone down to 284 percent — still an almost unheard-of gain on a risk-free trade.

Then there are the IPO investors — the so-called SPAC Mafia, or SPAC arb players. They certainly appear to be rational players. From January 2019 to mid-2021, they made a median 16 percent return, according to Cembalest’s calculations. In fact, their gains were the same in August 2021 as in March of that year.

“It was almost like free money to buy the unit and sell the announcement,” says the family office investor. The SPAC yield, he notes, is still greater than the 10-year Treasury bond. “Why buy government bonds when you can just flip SPACs?”

What’s perhaps most astonishing is that to keep the SPAC machine humming, the terms for these investors — as well as for PIPE investors — have only become more lucrative, according to Ohlrogge and Klausner.

“SPACs have been evolving recently in ways that make them even more expensive vehicles to take companies public, and thus in ways that will likely lead to even worse returns for shareholders who hold their shares through SPAC mergers,” the academics wrote in a new paper published in March.

Ohlrogge and Klausner found, for example, that to lure PIPE investors, an increasing number of SPAC sponsors are letting these institutional investors buy in at steep discounts, typically $8 per share. More-complex and opaque terms for private investments make it even harder to know what they are paying — and how much it will end up costing other shareholders in the end. (…)

More-lucrative warrant terms are also being used to entice IPO investors, and the traditional 24-month time frame to find a deal is being shortened to as little as a year, according to the professors.

Another relatively new effort they point to includes overfunding SPAC trust accounts by placing additional funds in them. Instead of $10 per share, the trust accounts now have $10.20, making them still more lucrative for those who paid $10 per share and redeemed, getting $10.20 instead.

But it’s something of a vicious cycle, which could lead to the downward spiral Ohlrogge envisions. Because the sponsors are typically repaid for the overfunding, he explains, “they drain even more value out of the SPAC and they have the potential then to lead to even worse returns for the SPAC at the time of the merger, which then could require even more generous benefits [to be] paid to the IPO-stage investors.”

Says Ohlrogge: “They need to find more ways to entice the IPO-stage investors to buy in, and that’s what they’re doing.” At least they’re trying. (…)

The SPAC model has always been an ingenious, if complicated, way to convince investors and companies alike to hop aboard the gravy train, and now sponsors (and their bankers) are coming up with creative ways to keep it chugging along. But Ohlrogge says some of the new features are only making things worse.

“They have the potential to turn into a death spiral for SPACs.”

Note: the whole Institutional Investor piece is well worth a read. Good stuff for the non-initiated. Also makes you aware that Wall Street does not have your back! Never.