So, You’re Finally Awake To America’s Inventory Problem

It wasn’t so long ago that the idea of “excess” anything seemed patently absurd.

The post-pandemic macro reality is defined by shortages, after all. Shortages of raw materials, shortages of energy, shortages of goods and shortages of the labor needed to meet pent-up demand for services.

But buried beneath tales of firms’ desperate efforts to secure scarce “stuff” was the story of how that desperation led to double-ordering, overstocking and over-hiring. Last week, management teams at America’s largest retailers began to tell that story.

Read more: The Week Retail Died

The risk to corporate profits is becoming more clear. Household budgets are under strain from the soaring cost of necessities, and that’s beginning to manifest in curtailed discretionary spending.

While it’s possible waning demand for consumer goods is explainable by goods-to-services switching, retailers who reported earnings last week left little room for doubt: Quite a bit of the “switching” involves diverting dollars to more expensive food and fuel, not shifting money from discretionary goods to dining out, entertainment and other services.

To the extent there is an inventory overhang, it’s another margin headwind. If you ask Morgan Stanley’s Mike Wilson, this is just now starting to get priced in.

“While we think the margin pressure and waning low-end consumer demand dynamics have been largely understood by the market, we think the excess inventory element and the associated risk to pricing is less understood and is just now beginning to be reflected in stock prices,” he said Monday.

Wilson has been warning about this for months. He’s been very specific. Often, analyst “warnings” are nebulous such that they can be cited later if they’re borne out, but forgotten if not. This isn’t such a case. Wilson predicted the dynamics currently manifesting in retailer guidedowns in no uncertain terms.

“[It’s] been evident in the macro data for several months,” he remarked, in his latest. “Real inventory levels for durable goods + apparel is now well above trend after surging recent[ly],” he said, noting that while “much of this is likely [due to] loosening of supply chains that took place in Q1 [and] is especially acute in general merchandise, it is broader than that and spans many consumer durables categories.”

He cited a compendium of quotes from Walmart, Home Depot, Target, Lowe’s, Kohl’s, Ross and others, on the way to noting that with Q1 earnings season now mostly complete, the trend Morgan flagged previously is intact. “This inventory dynamic is fairly broad across industries with all groups shown seeing an increase in their inventory versus sales growth spread on a QoQ and YoY basis,” Wilson said, referencing the figure on the left (below).

Unless there’s enough demand to absorb the inventory, it’ll have to be discounted. And plainly, risks to demand are skewed to the downside.

There are two ways to think about demand for goods, one of which might be described as the constructive take for the broader economy, and the other the not-so-constructive take.

If you’re an optimist, you could say spending will simply be diverted to services, and while that may bode poorly for anyone stuck with a stockroom full of unsold goods, it’s not necessarily an economic death knell. After all, America is a services-based economy.

If you’re a pessimist, you’ll likely scoff at the notion that “extra” money not spent on goods will automatically go to services when prices are up sharply for things families simply can’t do without.

I’d be inclined to the latter view, but regardless, the outlook for goods spending (and therefore the prognosis for firms sitting on what now appears to be too much inventory), isn’t favorable. “We see demand actually eroding for consumer goods due to high prices and overconsumption post-COVID,” Wilson reiterated, pointing to the figure on the right (above), which he said “implies real consumption growth of durable goods should fall further into negative territory in coming months.”

Finally, when you think about the ubiquitous “excess savings” narrative, it’s worth noting (as Morgan Stanley did) that the capacity to spend and the desire to do so are two different things. If you’re a middle-class family and you believe prices for groceries, gas and electricity are likely to remain elevated, at least in the near-term, you’re less likely to deploy whatever remains of your pandemic financial cushion on non-essentials.