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Consumers Are ‘More Strapped Than Usual’ Right Now

The consumer has always been in charge, but now more so than ever before.

While consumers have always held the key to the retail sector’s fortunes, the uncertain economic backdrop—one that includes sprinkles of recession risks— will require retailers to drill down on strategic operations planning in a year that starts out with the overhang of gross margin pressure from the fourth quarter.

The consumer and inflation

Surprisingly, consumers ended 2022 in a more optimistic mood about their inflation outlook. The Conference Board’s Consumer Confidence Index in December rose to 108.3 from 101.4, hitting the highest level since April 2022 following back-to-back monthly declines that began in October. Falling gas prices at the pump helped calm inflation expectations to its lowest level since September 2021.

In addition, price growth slowed by 0.1 percent in December, seasonally adjusted, reflecting the third straight month of declining inflation. Over the last 12 months, inflation rose 6.5 percent on an unadjusted basis per December’s Consumer Price Index. That’s down from 7.1 percent in November.

But some think the decline could be temporary. Consumers have started to shift some spending from goods to services. That is expected to continue in 2023, as will “headwinds from inflation and interest rate hikes,” said Lynn Franco, senior director of economic indicators at The Conference Board.

Complicating matters could be the rise in wholesale inventories, up 1.0 percent in November 2022 to $933.08 billion. October’s increase was just 0.6 percent on a revised basis. December data won’t be released until Feb. 8. Rising inventories suggest the economy is growing, and could fuel fourth-quarter U.S. GDP growth. But that growth, along with a relatively tight labor market, could make it harder for the Fed to hand down modest interest rate hikes to temper inflation.

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And while the jobs picture seems relatively strong now, the labor market could change quickly for a number of reasons. Businesses have to worry about interest rates that could force them to make bigger debt payments, on top of wondering if the economy will officially go into a recession. Plus, Microsoft’s 10,000-job layoffs and other similar workforce reductions are virtually guaranteed to leave their mark on consumer spending, which spells grim news for retailers selling clothing and home goods.

Economic indicators suggest that a downturn could be around the corner. The Leading Economic Index (LEI) fell 1.0 percent in November to 113.5, representing nine months of declines and the lowest level since March 2021.

Economists at Wells Fargo noted that while consumers seemed more confident in December than they were over the summer, they’re still seem cautious. A “large part of the Conference Board’s measure is determined by labor market health,” they wrote in a report. “The potential for rising [interest] rates to pull the floor out from under the still strong labor market is a real downside risk for 2023.”

“If a recession if in the cards, it will likely be rising interest rates that set it off,” Jack Kleinhenz, the National Retail Federation’s (NRF) chief economist, said, noting that “when the economy slows it becomes very fragile and the risk [of a downturn] rises significantly.”

In fact, consumer sentiment could change quickly. Maybe people will be spooked if there’s a sudden drop in the equity markets or have to pay huge home heating or grocery bills. Some might be facing the reality of steep credit card bills that carried their holiday spending Consumers have already started to borrow more from credit lines to fuel their spending. The New York Federal Reserve’s November report said third-quarter household debt jumped $351 billion to $16.5 trillion. That’s an 8.3 percent increase from a year earlier, and the biggest annual increase since a 9.1 percent bump in the first quarter of 2008 at the start of the Great Recession.

Consumer resilience amid the inflationary backdrop in 2022 could eventually erode household finances as people tap their savings and rack up debt. Consumers already might be showing signs that they’re tapped out. The U.S. Commerce Department’s December report showed that U.S. retail sales fell by 1.1 percent following a downwardly revised 1 percent decline in November. Retail sales were down 0.7 percent, excluding gasoline and autos. The numbers aren’t adjusted for inflation.

What retail is doing now

Natalie Kotlyar, national leader of BDO’s retail and consumer products practice, said retailers are facing a “trifecta effect” in January that could continue into the first quarter. Excess inventory carried into 2023, an uptick in returns of purchases and an increase in the number of consumers trying to pay off their buy now, pay later obligations will see retailers trying to clear out leftover goods as shoppers are “more strapped than usual.”

According to Kotlyar, the good news is that most retailers have shortened the period for returns from 90 days to 30, although some allow only 14 days to make sure they’re not getting back merchandise they won’t be able to sell. That limits most of the margin erosion impact to the fourth quarter, and curtails any overhang from outdated inventory at the start of the first quarter. Retailers start their new calendar year in February.

Some retailers and fashion firms clearly have recession risks on their mind as they head into 2023, fueled in part by the sudden shift in consumer shopping preferences that left them with too much of the wrong inventory in early 2022. They’re already starting 2023 with a bit more caution, pulling back on some orders as they try to figure out what’s going on with the consumer mindset.

“We are seeing retailers react to slowed demand by reducing orders and tightening inventory constraints,” said Chris Dodd, head of operations at Gelmart, the world’s largest intimates manufacturer and a supplier to Walmart. “Demand was still relatively high in the first half of the year. We started experiencing the shift after Labor Day.”

According to Dodd, his firm anticipates that retailers will continue to remain “cautious with inventory management through 2023.” He also said that in the event there’s leftover 2022 inventory that still needs to be cleared out in the first quarter, retailers with these inventory pressures could find themselves struggling to transition to spring/summer merchandise. It’s a scenario that could see them having trouble being “seasonally relevant,” Dodd said.

And according to Isaac Dabah, CEO of Tel Aviv-based Delta Galil Industries, “We’re seeing retailers take a more cautious and conservative approach with their first-quarter buys as they work through their existing inventories.”

Dabah added that his apparel company continues to focus on “reducing inventories by leveraging our multi-channel distribution network and taking proactive measure to ensure they will be in line by the end of the first half of the year.”

Other fashion companies are looking at how to grow their bottom lines to mitigate slowing consumer demand. American denim brand True Religion in November named Tina Blake to a new role as senior vice president, women’s design and brand image.

“Our goal over the next three years is to increase women’s sales from the 35 percent it is today to being on par with men’s at 50 percent of the business,” True Religion CEO Michael Buckley said.

Looking ahead, Buckley said, “For us, it is business as usual. Our product is retailing, so we see a build in orders for Q1 2023 versus Q1 2022.” He said jeans, T-shirts, polos, hoodies and jackets are selling well in the denim and sportswear categories. As for bottoms, consumers are looking for “cleaner washes that you can wear to work or going out.”

And Stylitics founder and CEO Rohan Deuskar said that because retailers are seeing freight rates decline versus year-ago figures, “there’s some safety in thinking they can hold back and order it later. They can see what’s going on first before placing orders, which is contributing to lower inventory levels in many cases.” His firm provides visual inspiration options and bundling—and hopefully additional cart items—when consumers click on an item they are interested in purchasing online.