The Great Swindler

Back in April, during Berkshire’s first in-person annual meeting since 2019, Warren Buffett described inflation as an equal opportunity swindler.

It swindles equity investors, he said, but it “swindles the bond investor, too.” It also “swindles the person who keeps their cash under their mattress.” Ultimately, Buffett mused, “it swindles almost everybody.”

Of course, just because everyone gets swindled doesn’t mean everyone shares the burden of inflation equally. Buffett, for example, is at no risk of being forced to switch to store brand soda from Cherry Coke to sate his famously rapacious thirst for sugary refreshment.

That said, the scourge of inflation is climbing the income ladder like poison ivy. Even if it never touches the Buffetts of the world, it may alter, or even erode, the spending habits of those we typically identify as “well-off” in an everyday sense of the term.

That dynamic began to show up in earnest during this quarter’s earnings calls, when Walmart boasted of “more middle- and high-income shoppers.” Really, though, it was apparent last quarter, when Dollar General CEO Todd Vasos told analysts that the chain was “starting to see that next tier of customers shop[ping] with us a little bit more.”

Fast forward to the discounter’s Q2 results and Vasos again made mention of that “next tier,” only this time, he was more explicit. “We saw growth in the number of higher-income households shopping with us, which we believe reflects more consumers choosing Dollar General as they seek value,” he said, on the company’s call.

Dollar General’s results were decent, but Dollar Tree, which is in the middle of a corporate turnaround, saw its shares pummeled thanks in part to the size of new pricing investments at Family Dollar, which accounted for 60% of a $0.75 per share downward adjustment to the midpoint of the company’s full-year profit forecast. The rest was attributable to “a material shift in consumer purchasing from higher-margin discretionary merchandise to lower-margin consumable goods,” a familiar trend flagged by a number of retailers, as well as “inflationary cost pressures” and “continued investments in labor, wages and store conditions.”

On a number of occasions recently, I’ve mentioned the prospect that if inflation can moderate even a little bit, wage growth at the low-end of the pay scale can overtake the pace of price gains, perhaps bolstering spending by those with the highest marginal propensity to consume. The flip side is that inflation would have to recede far more in order for wage growth higher up the scale to outstrip gains in consumer prices. In a bulletin dated August 24, Bank of America Institute noted that aggregated internal card data showed total credit and debit card spending per household excluding grocery, gas and clothing for those with annual incomes greater than $125,000 contracted for a third straight month in July (figure below).

That was the weakest showing across income cohorts. I assume this is obvious, but the exclusion of grocery, gas and clothing is purposeful — that’s so-called “necessary spending,” and thus isn’t as responsive to deteriorating personal finances.

Note from the visual that the largest drop in spending last month came among households making between $75,000 and $125,000. By contrast, the lowest income cohort actually increased discretionary spending in June and July.

BofA attributed the disparity in part to the same wage growth dynamic mentioned here of late. Median wage growth for the lowest income quartile actually outran headline PCE last month (figure below).

Meanwhile, wage growth for the top income group remains woefully short of inflation.

I’ll confess I had a difficult time conjuring a title for the chart. Initially, it was “above water,” but that seemed disingenuous. After all, the lowest income quartile is the furthest thing from above water in a financial sense. The highest earners may be seeing their wages eroded by inflation (and at a fairly rapid clip), but suffice to say those earners are still doing substantially better than their fellows at the low-end currently “enjoying” the benefits of marginally positive real wage growth. Hence, “small comfort.”

In any case, this has ramifications for the economy. I’ve emphasized how critical it is that those with the highest marginal propensity to consume are able to keep spending. That’s the “impulse” — the flow, if you will. As BofA put it, “lower income households’ spending can have a bigger impact on the rate of change for overall consumer spending given their higher MPC.”

That said, higher income households are important for aggregate spending because… well, because they have more money to spend. BofA emphasized that the highest 20% income quintile made up almost 40% of total consumer spending in 2020.

Increasingly, it seems as though only the truly affluent are immune to inflation, Buffett’s “great swindler.” Note that Williams-Sonoma had a decent quarter. Not exactly Balenciaga, I know, but a 20 oz bottle of “sunny orange dish soap” will run you $15, and if you want the matching 68 oz refill, you’re looking at $54. Their Q2 comps were +11.3%, double estimates.

Meanwhile, back at Dollar General, “the customer is reacting just like we thought she would,” as Vasos told JPMorgan’s Matt Boss on Thursday, when asked about the behavior of the discounter’s “recently acquired” customers. “She’s being very intentional in her shopping patterns while she’s inside the four walls of the Dollar General store,” he went on to say, noting a “skew” towards need-based purchases.

Vasos went on. “The great thing is that if we do have the right product out there — which we do — on the discretionary side, she’s shopping [for] that as well.” Halloween spending at Dollar General “is off to a fabulous start,” he noted.