One of the big questions surrounding the state of the US economy has to do with the strength of consumers, whose spending is the main driver of economic activity. Evidence so far is mixed, but American consumers appear to be far more resilient than most estimates projected them to be. A report by Adobe estimated spending during this year's Black Friday at more than $9.1 billion, setting a new record and beating estimates. Even if the 2.3% year-over-year increase occurred in the midst of high inflation, it is a good sign for retailers ahead of the December shopping season.
Data released this month (Nov. 16th) showed that retail sales in the United States registered their biggest month-on-month increase since January. The amount spent in October was approximately $695 billion, up 1.3% from September, beating market expectations of a 1% rise. An estimate by EY estimated that in volume sales had risen by 0.8%, which serves as a reminder that higher prices are playing an important part in nominal changes.
Compared to a year ago, retail sales increased 8.3% nominally. Again, we can assume inflation—at 7.7 percent for the year ended in October—explains at least a significant part of this growth. But even if the real growth of rate were close to zero, the figure would still serve as evidence of robust consumption, especially considering the disappointing growth results for the first two quarters of 2022. In terms of monetary policy, the Fed could take these numbers as a sign pointing to the need of higher rates for a longer period.
As for more worrying signs, credit card debt keeps racking up: data from the Federal Reserve Bank of New York show that at the end of Q3 it had grown by more than 4% over the previous quarter, reaching $925 billion. Credit card balances grew 15% year-over-year, the largest in more than 20 years. These data show that higher levels of debt are undergirding part of the resilience we see in consumers.
Walmart & Target: two different pictures
We can also gauge how well consumers are doing by looking at the results of major retailers. However, the most recent earnings reports of two of biggest retail corporations in the United States tell quite a different story: Walmart's depicted a much stronger American consumer than that of Target. Accordingly, the market's reaction to their Q3 results was drastically different.
Let's start with Target, whose report on November 16th sent the stock tumbling down 13% on the day. The company not only informed of results far below its own expectations, but also provided a bleak outlook ahead of the end-of-year shopping season, lowering its earnings guidance for 2022. The company cited inflation and the higher cost of borrowing as key drivers behind consumers' decision to scale back their spending. Depleted savings and higher levels of economic uncertainty are likely also playing a role.
Target has been burdened with high inventories this year, forcing it to reduce prices. The company stated it would seek to reduce costs over the next three years in a range of 2 to 3 billion dollars. Target had projected operating margins of 8% for this year, but it has now lowered them to 3%. In fact, Q3 showed profits down by more than 50%, while revenue actually increased (slightly, though). Relative to analysts’ expectations, earnings missed by approximately 30%. The company has now missed analysts’ expected earnings per share for three consecutive quarters, which explains the drop in the stock price: approximately 20% this year.
On the other hand, Walmart, which reported results the day before Target, depicted a much tougher consumer. Results beat expectations—sales were up 9%—and the company's earnings guidance for 2022 improved. Despite Target's report bringing down not only its own stock but that of other major retailers, Walmart's gained 7% the day the report was released, and continued to climb even after Target's bad news.
One key difference between Walmart and Target: the weight of groceries. At Walmart, almost 50% of revenue came from the sale of groceries in 2021, whereas for Target that number was only 20%. As consumers cut back on spending, they are more likely to pass up on non-basic or discretionary items, of which Target sells more. The amount households can reduce in food expenditures can only go so far, which benefits Walmart, even though margins are far smaller in groceries. Moreover, Walmart has benefited from new consumers: wealthier customers that used to shop at costlier stores are now patronizing the Arkansas giant. The stock has gained more than 15% in 2022.
Despite the starkly different performances this year, since January 2020 both stocks have performed remarkably similarly (Figure 1). If we look at the price relative to forward earnings, on the other hand, Target is trading at a steep discount relative to Walmart (around 30% on November 30th).
In conclusion, consumer data shows demand is holding up in spite of high inflation and the steep rate increases we have seen since March. Retail, overall, is also doing fine, but firms with a greater focus on non-discretionary items clearly have the edge in an environment where consumers’ purchasing power is weakening.
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