The stock market tanked on Sept. 13 in the worst sell-off since June 2020. The market has struggled to regain its footing ever since. The Dow Jones has lost nearly 5 percent of its value this month alone. Ouch. The catalyst for this drop? The August Consumer Price Index (CPI). Should we be concerned? On the one hand, yes, we should; but on the other, the sell-off shouldn’t be surprising.
Let me explain. It seems that the market got ahead of itself by pricing in assumptions that inflation was easing as gas prices were falling. However, Wall Street analysts forgot that prices for everything—except fuel—rose last month. Indeed, the market was inflated based on a false assumption that declining fuel prices would lead to lower prices for non-fuel products. In time, that may be the case, but in August, prices for fuel and non-fuel products went in opposite directions.
For apparel, prices were up by 0.2 percent in August from July; gasoline prices fell by nearly 11 percent. So for the year through August, apparel prices are up by 5.1 percent over the same period in 2021. OK, should we be surprised? Not really. In the world of order fulfillment and supply-demand convulsions, prices remain elevated as it will take time for any price declines to be reflected in the CPI data. For sure, if demand weakens, prices will fall sooner than later. Uh oh.
Recession around the corner?
This brings us to my next point: It’s not big news that the U.S. economy may be slipping into recession. And tight monetary policy by the Federal Reserve may aggravate the situation. Moreover, many indicators suggest that things are edgy now but poised to even worsen.
In the world of economic forecasting, what appears to be the case today, can suddenly change—skewing any projections. Prognostication is a tricky business, particularly when it comes to forecasting future consumer behavior. Are we going into recession? Maybe, maybe not. However, some clues in current statistics suggest the most likely course of the economy—and, by extension, the health of American retail. A few statistics stand out, some widely published, some less so.
We could examine all sorts of statistics compiled by the government, academia, and private sector. There are lots of series from which to choose. But there are a few worth mentioning as they provide easy-to-discern indicators of current conditions and imply what may be coming around the corner.
Digging for data
Let’s begin with inflation rates for the retail apparel industry. As we discussed, apparel prices rose in August and remain higher in 2022 than in 2021. Check out this graph:
Apparel prices in 2020 are running well ahead of 2021. As it appears that inflation will plague the industry for some time, expect significant discounting by retailers as they attempt to offload high inventories. In turn, this will help moderate consumer inflation rates—at the expense of retail margins.
Speaking of inventories, another series worth mentioning is apparel retail sales and inventory statistics: an essential measure of the relative health of the retail business.
A ratio above 2 means the retail apparel business is struggling to offload excess inventory. At 2.22 in July, the industry is under stress. What’s more, the ratio has risen since last year, up from 1.77 in July 2021.
Let’s turn to the interest rates the Federal Reserve charges to banks. When inflation rears its ugly self, the Federal Reserve is on the case to raise interest rates to quell the beast. Indeed, the super-low rates of 2021 have fallen away as the Fed raised rates throughout 2022.
For sure, the road ahead for the Fed will be challenging to navigate. We’ll know more after the Federal Reserve’s Board of Governors meets this week on Sept. 21 to decide on a specific rate hike. It could be a significant increase. Yikes.
Interest rate hikes directly affect consumer purchasing, which brings us to retail apparel sales. Retail apparel sales have weakened considerably since 2021, when a bounce in consumer spending helped to propel transactions. However, in 2022, the bounce has lost its vigor, while retail apparel sales are sluggish at best:
Overall retail sales rose in August, but retail apparel sales have been flat since last summer. This signals that U.S. consumers continue to spend at more subdued levels compared to the boom coming out of the pandemic in 2021. Further, any gains recorded in August were primarily due to inflation, not necessarily more SKUs sold.
But a key factor for retailers will be consumer sentiment. Oddly, low prices don’t always translate into higher sales during inflationary times. This is because consumer psychology plays an outsize role in purchasing decisions. For example, in 2022, American consumers have signaled concern over the economy’s health and future financial prospects. See what I mean:
Consumer sentiment appears to have bottomed in June and has stabilized since. It’s a good sign—and a leading indicator. If people feel better about their prospects, they’ll be more inclined to shop and spend. And suppose inflation is easing for essentials, like gasoline? In that case, people will have more disposable income to spend on other products, like clothing. Of course, perceptions play a prominent role, but in 2022 shoppers have yet to turn out as they did during the recovery last year from the pandemic.
Not surprisingly, wages and employment help shape consumer sentiment. In turn, inflation is driven by supply-side and demand-side factors such as wage growth and low unemployment. Suppose people are at work and are receiving higher wages for their work. In that case, that will, in theory, translate into higher demand for goods and services. However, too tight a labor market and increased demand will put considerable stress on supply chains to meet such demand. In turn, meeting demand will result in higher prices. Check this out:
Another consideration is commodity prices. Oil prices are falling, although one would think the opposite would occur in inflationary times. The same goes for cotton. Indeed, between the floods in Pakistan and drought in Texas, a supply shortage in more conventional times (pre-pandemic), prices would soar based on simple market fundamentals. Yet, although futures prices have increased in recent months, they still haven’t taken off. Why? Lingering concerns over weaker demand for cotton. The same may be said for energy commodities, too.
The bottom line?
I know the previous section was a bit wonky. Still, it’s essential to place the statistics in context to draw conclusions. To summarize, inflationary price pressure churns the retail market. Everything seemingly costs more, while at the same time, unemployment remains low and wages are higher. This suggests increased consumer purchasing power, although retail apparel sales are flat, meaning consumer purchases favor essentials over clothing. Moreover, although no longer in freefall, consumer sentiment is dismal, which does little to cheer sellers of discretionary consumer products.
The net result for retailers is uneven consumer demand, higher inventories, and significant discounting to encourage more consumer spending. Finally, the Fed will likely hike interest rates later this week to restrain inflation—even though such increases risk tipping the economy into recession. The prices of some commodities—such as cotton and gasoline—have retreated in recent weeks, but this may be a function of weaker demand.
Bottom-line: Recession looks more likely than not, as the odds of the Federal Reserve raising interest rates high enough to stall the economy are increasing. However, we’ll just have to see whether it’s a deep recession or just a bump in the road. Time for a road trip. Or maybe not. It appears we narrowly averted a nationwide rail strike. The great news keeps coming, folks.