Both Target and Walmart, two of the nation’s largest retailers, released their financial data for their first quarter. Both had large decreases in profit, even though sales increased. Retail sales nationwide are increasing, yet profit for other chains is also falling. This spells bad news ahead.
Increased costs for wages, energy and the products these retailers purchase for resale have increased substantially. Yet their cost increases cannot be fully recovered by raising prices to consumers, which is why their profit is falling.
For the last year, inflation at the consumer level has increased by 8.3%. Prices at the producer level have increased more than 11%. That means business has not been able to pass along the higher prices to consumers. This is the cause of the decrease in profits. The immediate future will be troublesome, not just for these large retailers but for the economy as a whole.
The high inflation at the consumer level means that households are paying more for all goods and services, especially necessities. Since the average wage increase is much smaller than the average price increase, consumers have less money left over to purchase non-necessities, meaning that consumers will purchase less.
As that happens, business will begin to produce less and the economy will slow down, eventually leading to recession. While most economists believe that a recession is at least six to nine months away, this recent data indicates the recession may come much earlier. Already the economy had negative growth in the first quarter of this year.
The worst scenario, which now seems likely, is that inflation persists as economic growth slows. When the economy stagnates as inflation persists, stagflation results. Remember the Carter years?
Most economists are forecasting small, but positive, economic growth for the second quarter of this year. The first estimate of second-quarter growth won’t be available until the end of July. If the second quarter is negative, that would mean two successive quarters of declining GDP which was the historical definition of recession.
Even if economists are correct and the second quarter shows positive growth, it is likely to be low, perhaps in the 2% range. Inflation is likely to worsen in the coming months which would put downward pressure on economic growth.
Stock market values are dropping substantially. This often signals a recession is coming. The price an investor is willing to pay for a share of stock depends on the expectation of future earnings. Since investors expect a recession that will reduce corporate profits, they are willing to pay much lower prices for shares of stock.
Retailers like Target and Walmart will continue to struggle. Inflation will worsen in the coming months, with much of the increase due to rising food prices. Farmers are now talking about how much the cost has increased for fertilizers, labor and diesel fuel. These higher input prices will result in a higher cost to produce. In order to continue to be profitable, prices must rise.
The only solution to the inflation problem is for the Federal Reserve to continue to reduce the rate of growth of the money supply by selling the bonds that they purchased last year. Those bonds were purchased because the Fed wanted to accommodate the Biden Administration’s desire to overstimulate the economy.
The bond buying program, which started in March 2020 and ended in March 2022, resulted in a rapid growth in the money supply since the Fed simply electronically prints money to buy those bonds.
The Fed will have to get very aggressive with its interest rate increases in order to curb inflation. That means at least a 50 basis point increase in June and another 50 to 75 basis point increase in July. While that action will reduce demand and put downward pressure on prices, it will also lead to a slowing economy. Forget about a soft landing.
Target and Walmart’s poor profit results are just the beginning. Watch for other companies to report poor profits likely leading to a recession or worse yet stagflation.