A new trend in retail … why “The Big Short” guy is betting on disinflation … a troubling trend from the rental market that will make you think twice about disinflation
Imagine going to Target in order to return an item you bought last week.
The cashier hands you your refund. But as you attempt to give her the product, she waves you off.
“Nah, you keep it.”
You walk out of the store with both your cash and a free whatever.
Retailers have so much inventory today – too much inventory – that they’re now considering adopting this “you keep it” response as a new return policy.
Given the never-ending supply-chain crisis, retailers have been unable to accurately predict appropriate inventory levels. The result is that many of them are now sitting on huge gluts of unwanted product, filling stores and warehouses to the brim.
So, when a would-be returned product comes back to the store, with no good place to put it, retailers are considering simply providing a refund…while letting the customer hang on to the product.
***Years ago, in my MBA program, I took a supply-chain management class that touched on this problem
As an exercise, our professor lined up 10 students. The furthest left student was the raw-materials manufacturer. The furthest right student was the point-of-sale store manager.
The goal of the exercise was for the raw-materials manufacturer to accurately supply the point-of-sale manager with the right amount of product at the right time – despite the marketplace hiccups the professor threw at us.
The wrinkle was that information about “goods produced” on the supply side versus “goods wanted” on the demand side had to be passed through this chain of 10 students, one by one, like the children’s game “telephone.”
Because there’s lag time between ordering product from the manufacturer and actually getting it in the stores for sale, this created the potential for big inventory problems.
What we realized was that by the time the raw-material manufacturer had updated information about customer demand and its impact on inventory needs, an incorrect amount of new product was already moving through the supply chain – either too much or too little.
Today, this exercise is playing out in real time with major retailers. And “eh, you hold on to it” could be the result.
***So, is this going to reverse inflation and lead to a new disinflationary environment?
It is, according to Michael Burry.
Burry is the hedge-fund manager running Scion Capital. He’s best known for his bet against the housing market, which was made famous by Christian Bale in the movie “The Big Short.”
He’s a very smart guy. It’s worth paying attention to what he says.
Burry believes the supply chain/inventory problems we just looked at – called a “Bullwhip Effect” – are going to result in disinflation and a policy reversal from the Fed later this year.
The idea is that retailers, loaded down with too much inventory, will have to drop prices to get rid of all their stockpiled goods. This price reduction is inherently disinflationary.
Here’s Burry’s tweet:
And here’s Bloomberg with other signs we might be headed for such disinflation:
…The economic data has been deteriorating.
The Federal Reserve Bank of Atlanta’s widely followed GDPNow Index, which aims to track the economy in real time, is showing no growth for this quarter.
The Dallas Fed’s survey of manufacturing intentions released on Monday dropped its lowest reading since the early days of the pandemic in May 2020.
The “deflationary pulses” that Burry referenced may be happening now.
It seems very likely that the Consumer Price Index report for June, scheduled for July 13, will come in comfortably below the 8.6% recorded in May.
To believe otherwise would require ignoring a mountain of economic data.
***If this Bullwhip Effect picks up steam, prepare for a battle between disinflation and missed earnings
At the end of the day, disinflation would be a welcomed change from our current raging inflation, but as investors, what we care about more are earnings. After all, in the long-term, earnings are what drives your portfolio.
Burry could be correct. But let’s take it one step further.
To whatever degree the Bullwhip Effect is disinflationary, would it not be equally profit-eroding?
All those goods littering store shelves that no one now wants? Wasted dollars.
The expense of warehousing this supply glut? Wasted dollars.
The hit to corporate bottom-lines if they adopt a “here’s your refund, you keep it” policy? Wasted dollars.
From CBS News:
“For every dollar in sales, a retailer’s net profit is between a cent to five cents. With returns, for every dollar in returned merchandise, it costs a retailer between 15 cents to 30 cents to handle it,” said [Burt] Flickinger [retail expert and managing director of retail consultancy Strategic Resource Group] …
“Retailers are stuck with excess inventory of unprecedented levels. They can’t afford to take back even more of it.”
By the way, what’s to stop fraud?
In other words, people go buy a product that they hear through the grapevine is overstocked, then simply “return it” a day later for both cash and the product.
It’s basically a wealth transfer from retailers to unscrupulous shoppers.
The upcoming Q2 earnings season was already going to be critically important due to what we’d learn about consumer demand in light of inflation.
Now, it’s even more important due to what we’ll learn from CEOs on their earnings calls, discussing the potential impact of this Bullwhip Effect on bottom lines.
***Keep in mind, even if the Bullwhip Effect is disinflationary for retailers, there are bigger battles to fight
Let’s follow the breadcrumbs…
Earnings are the name of the game for us investors.
And where do earnings come from?
From purchases made by consumers like you and me, with disposable income we have after paying our cost-of-living expenses.
Clearly, our cost-of-living expenses have a huge impact on our ability to spend, and therefore, on retailers’ profitability.
And what’s happening with these expenses?
They’re soaring, thanks to inflation.
Let’s look at the worst offender – shelter costs.
For some context, the four components of U.S. Gross Domestic Product (our proxy for the U.S. economy) are personal consumption, business investment, government spending, and net exports.
In 2019, this broke down as 70% personal consumption, 18% business investment, 17% government spending, and negative 5% net exports.
Clearly, “personal consumption” is where the magic happens.
You know where this is going, but what’s the biggest line item within personal consumption?
Hint – it’s not a toaster or new patio chair from Target.
It’s shelter costs, meaning your mortgage or rent.
The most recent data available is from 2020, showing that housing accounts for 29% of average household expenditures. That represents about a one-third weighting of the CPI calculation.
The second-largest line item for households was transportation, coming in at a distant second place of 13%. Food was third at 10%.
Obviously, shelter costs are an enormous and unrivaled expense for household budgets.
So, retailers can Bullwhip all they want, but here’s what’s happening over in the “shelter” part of the economy…
Actually, let’s get specific– from recent Digests, you already know that the price of the average home just notched an all-time-high. And you know that mortgage rates are exploding, having surged 118% since the beginning of 2021.
But renters are safe, right?
From yesterday in Yahoo! Money:
The median monthly rent in May hit $1,849, a 26.6% increase since 2019 before the pandemic, according to Realtor.com’s Monthly Rental Report.
“Single-family rents continue to increase at record-level rates,” Molly Boesel, principal economist at CoreLogic, said in a statement regarding its Single-Family Rent Index (SFRI) report.
“In April, rent growth provided upward pressure on inflation, which rose at rates not seen in nearly 40 years. We expect single-family rent growth to continue to increase at a rapid pace throughout 2022.”
In both New York and Miami, rents are up 40%. New York’s average rent in May was nearly $5,000.
This situation is growing so out-of-whack that would-be renters are now engaging in bidding wars.
From The Wall Street Journal:
Bidding wars have long been a staple of hot housing markets, where buyers compete with offers above the seller’s listing price. Now, these contests are becoming more commonplace in the rental market.
Real-estate agents from New York to Chicago and Atlanta say they see more people than ever making offers above asking to lease homes and apartments that they will never own.
An increasing number of white-collar professionals—some of whom recently sold homes—are reluctant to buy because of record-high home prices, rising mortgage rates and limited supply.
They are renting instead, helping to drive a frenzy for leased properties of all kinds, and helping fuel the trend of offering above asking rents, real-estate agents said.
In Chicago, some apartments are going for 10% to 15% over ask.
Meanwhile, the CEO of Tricon Residential reports that in any given week, large rental landlords are getting over 13,000 rental leads for just 200 available rental homes.
Now, over in the homeownership market, there are signs that prices are peaking, courtesy of record-high prices and mortgage rates that are about 6%. And in recent Digests, we covered a story suggesting a housing correction is coming.
But what’s going to slow down rental rates other than broad consumer pain? As we just saw from the Yahoo! article, the Corelogic economist is calling for “rent growth to continue to increase at a rapid pace throughout 2022.”
Now, apply that to the 35% of the nation that rents instead of owns.
Bottom line, yes, the Bullwhip Effect over in retail is likely to be disinflationary. But will it be enough to offset nosebleed shelter costs?
I don’t know, but it’ll take a lot of returned toasters.
We’ll keep you updated.
Have a good evening,