Target department store's CEO announced yesterday that the big box chain’s second quarter operating margin was about 2%, lower than the company had projected just three weeks prior. The solution? Target immediately put everything on sale to reduce inventory.
The news was not lost on Liz Ann Sonders, Charles Schwab’s chief investment strategist, who said during the firm’s Market Talk yesterday that she sees the combination of slumping retail sales and Americans’ saving rate as concerning.
“We never want to discount the power of the consumer to keep spending, but I think that we’re at the point in this cycle where you have to look at month-over-month changes. In the case of retail sales, month over month since January, we’ve gone from 2.7% to 1.7% to 1.4% and then, in the most recent month, to .9%, so we have started to see this deceleration,” Sonders said.
In addition to a drop in the savings rate to lower than before the pandemic, Sonders said it wouldn’t surprise her if there is also a slowing rate of payroll gains, which has often been a precursor of recession.
“I think when you look at the tightening cycles and you go back to the modern post World War II era, we’ve had 13 rate hike cycles, 10 recessions and three soft landings, and when you add into the mix [slowing] first quarter growth, I think maybe the needle moves a little bit toward recession,” Sonders said.
Schwab doesn’t think this a 2007 or 2009 epic type of recession where there is “an overly indebted financial system that crashes along with housing. Were we to go into a recession, it would be more the classic end of a cycle where you have overheated growth or overhead inflation and the Fed steps in and they tighten policy. You have to do that to reset,” Sonders said.
As for soft landings, she said she is doubtful. The last so-called soft landing was in 1994, when the tailwind of a powerful tech boom kept the U.S. economy afloat.
Now, the U.S. is dealing with a 40-year high in inflation and a very low unemployment rate, which is a trailing indicator of recession. “If you look at the combination of the inflation environment and unemployment rate any time since the 1950s and forward, where you had inflation more than 4% and unemployment less than 5%, you were either in the lead in to a recession or already in one. And obviously the inflation rate right now is about double that and the unemployment rate is about 3.6%,” Sonders said.
While the Federal Reserve would love to engineer what she called “an immaculate tightening,” where board members are able to aggressively bring down aggregate demand to combat inflation without negatively impacting the labor market, “it’s pretty tricky to do. The Fed can see they really only have control on the demand side of the economy,” Sonders said.
A path to a soft landing could occur if supply side issues begin easing, there are enticements to bring more people into the labor force and the Fed uses its “blunt instrument” of monetary policy to focus on the demand side to combat inflation, she said.
“It's doable, but I just think when you look at the unique factors of not just 40 year highs of inflation but the fact that first-quarter growth was already in negative territory and the unique aspects of the pandemic associated with more recent things like China’s lockdown, the fallout on supply chains, Russia’s war in Ukraine and the Fed’s simultaneously starting to shrink a $9 trillion balance sheet, I think the needle moves a bit more toward recession than soft landing,” Sonders said.
The seven-week-old ”stealth bear market,” as Sonders called it, isn’t helping. “We thought the indexes were going to play a little catch up,” she said. Instead the average S&P investor is down 30% and the average Nasdaq investor is down 50%.
As for the Fed’s immaculate tightening, Kathy Jones, managing director and chief fixed income strategist for the Schwab Center for Financial Research, said during the webinar that Schwab is expecting two 50 basis point rate hikes at the June and July meetings, followed by two 25 basis point hikes.
“That’s pretty well baked in. We’ve been told that explicitly by many Fed members, so that’s a reasonable expectation,” Jones said.
“We are looking for them to stay on course, until there are signs that inflation comes down,” she added.