Summary
• Retail inventories remain historically low. The rebuilding effort and ongoing consumer demand suggest goods inflation and supply-chain problems could be slow to dissipate.
• Upcoming Black Friday and Cyber Monday could signal whether retailers have pricing power and can avoid heavy discounting.
• Our underlying macro view remains that consumer spending will shift from goods to services, but this transition could be slower than we originally thought.
Recommendation
• We continue to recommend underweighting the retail ETF XRT and overweighting SPY, PEJ and JETs. But this may be a patient trade.
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Summary
- Retail inventories remain historically low. The rebuilding effort and ongoing consumer demand suggest goods inflation and supply-chain problems could be slow to dissipate.
- Upcoming Black Friday and Cyber Monday could signal whether retailers have pricing power and can avoid heavy discounting.
- Our underlying macro view remains that consumer spending will shift from goods to services, but this transition could be slower than we originally thought.
Recommendation
- We continue to recommend underweighting the retail ETF XRT and overweighting SPY, PEJ and JETs. But this may be a patient trade.
Walmart (WMT) and Target (TGT) recently reported inventories up 11% and 17% YoY, respectively. Initially, it appeared that they were overstocking ahead of the holiday shopping season – and that the worst of the supply-chain problems might be passing. There even seemed a risk that retailers could get caught with too much inventory come 2022.
But a closer look at inventory trends shows retailers have been reducing inventories relative to sales over the past two years (Chart 1). They apparently consistently underestimated consumer appetite for stuff since Covid hit.
It further appears that even with the holiday build-up, WMT and TGT inventories are still historically low. And other smaller retailers such as Macy’s (M)and Kohl’s (KSS) are far behind the curve. This may simply reflect supply-chain delays, and their inventory is now accumulating by the day and returning to more normal holiday levels.
It is also possible that inventories will remain tight through the holidays, and that retailers still have low inventories come 2022. In this scenario, they will be able to avoid discounting merchandise and will need to keep ordering in 1Q 2022 to rebuild inventories.
If these tea leaves say anything, it is that consumer demand for goods and retailer restocking could remain firm well into 2022. That in turn implies supply-chain problems and goods inflation may unwind more slowly than people hope.
One early indicator may be how aggressively retailers offer early shoppers discounts on Black Friday and Cyber Monday.
We Still Look for Spending to Shift to Services
Our view since mid-June has been that consumer spending will shift from goods to services. Consequently, we have recommended underweighting the retail ETF XRT and overweighting the broader S&P 500 ETF SPY. Following the recent elections, we recommended overweighting the service-oriented ETFs PEJ (casinos, theme parks, entertainment) and JETS (airlines).
That continues to be our macro view, and we continue to recommend these trades. But given ongoing trends in retail sales and now inventories, we also acknowledge this transition may take longer than we originally thought.
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)