Perhaps the best way to describe today's economy is a line borrowed from Charles Dickens; "It was the best of times, it was the worst of times." Traditional economics says that corporate profits rise when consumer spending rises. But today, we are not in traditional times. Welcome to the odd, confusing, and a historically rare economic condition called "stagflation," where costs rise (for both the consumer and the producer) while the economy slows. Sprinkle in some ongoing and after-effects of a global pandemic, supply chain issues, and the impact of an expanding global military conflict. You also see conditions highlighting the safe-haven status of precious metals, with a side-order of once-in-a-generation timing for outsized gains in the intermediate term (2-5 years). You arrive at an economy that is difficult even for the experts to navigate, let alone the average consumer in America today.
Recent numbers indicate how confusing it can be for economists, CEOs, elected officials, and even the Federal Reserve to navigate the economic seas of today. We have previously discussed the routine difference between "real vs. nominal interest rates," whereby positive nominal interest rates have become negative real interest rates compared to inflation. In other words, earning 3% interest on a savings account today is the same as losing 6.1% interest when inflation is at 9.1%. The equation is "Interest Rate - Inflation Rate = Real Interest Rate ." In this example, 3% - 9.1% = (-) 6.1%. The actual number is lower than -6.1%, as few Americans earn 3% on a savings account today. But what about real vs. nominal sales, real vs. nominal profits? These are topics that are confounding the economic leaders of today.
Higher Spending, Lower Sales
Typically higher consumer spending translates nicely into higher sales and higher profits. But today, consumers are spending more but purchasing less. This seems counterintuitive, but consider this 2015 example regarding coffee. People were drinking more coffee than ever, paying more money but buying less coffee than before. With the advent of the single-serve coffee machines, people began drinking most of the coffee they made. Half the pot would be poured down the sink when the coffee pot was the method of choice. So, more coffee was being sold, but less was being consumed when everyone made a pot of coffee. It was a curious example of an oddity that didn't affect much outside the coffee industry realm. Today we have something similar happening that touches nearly every industry, creating great difficulties managing and storing inventories and projecting sales and profits.
The world's largest retailer Walmart, recently issued a profit warning for the 2nd time in 3 months, as they are having trouble managing inventories and dealing with the discounts required to move out unwanted inventories. They are not alone. Companies, as varied as Amazon, Home Depot, Target, Bed Bath & Beyond, Macy's, and GAP have admitted to similar challenges since May this year. It can also be seen in the stock prices of several in the retail sector (see chart).
Difficulties with shipping delays last fall meant that some items ordered did not arrive until after the Christmas season, too late to impact profits last year. This spring, much of that inventory had to be sold at steeply discounted prices or held in storage for the shopping season this year. But the costs of newly leased warehouse space have increased 54% for the 2nd quarter of 2022, further eating into profitability for many retailers. Shipping rates are another concern. While shipping costs have dropped 2/3 from the highs seen last year, it still costs 4x more than in 2019 (pre-pandemic) to get containers from Asia to the United States. Many retailers remember the sting of not having inventory for Christmas last year. They have already ordered excessive amounts of items on hand, which was expensive to ship and are now expensive to store.
But consumer spending habits have changed in the face of the highest inflation in decades, and so have the spending requirements for the businesses seeking to serve those consumers. The upcoming "Back to School" shopping season is being viewed by some as a possible barometer to gauge how the holiday shopping season might go. As the graph from the National Retail Federation shows, the average family plans to spend 2% more on back-to-school items. But retailers expect lower revenue from the increased spending and may sell fewer items even though families are spending more due to inflation. There is currently a double-squeeze from retailers' inflation, consumer inflation (CPI is 9.1%) limiting sales, and producer inflation (PPI is 11.3%) limiting profits. This comes in the face of corporate layoffs and recession, as companies from convenience stores to banking idle up to 20% of their workforce.
Recession (?) - By Any Other Name…
The recessionary part of stagflation that was absent when the rising inflation numbers began to climb has officially arrived. While some are attempting to redefine what a recession is not, there have been no solid redefinitions as to what a recession is. So using the old definition used to describe recession for the last 50+ years, looking at 2Q 2022 GDP numbers indicates we are in a recession. When we combine this with inflation levels not seen since the 1980s, the issue of stagflation can no longer be denied. We began informing our readers of this possible eventuality just over a year ago but are not necessarily thrilled at the problematic conditions stagflation can bring to many Americans. Thankfully, precious metals offer an opportunity for reprieve.
In the face of lower bonds, stocks, and cryptocurrencies, and an economic environment that few have seen before, precious metals lead the way. While it may not feel like it, precious metals are among the best performers thus far in 2023, proving their "mettle" as a source of stability in troubled times. But the party is just getting started. During and following the last major stagflationary period, gold and silver saw incredible gains of 3x-5x in a few short years. I expect we will see similar results this time as well. Whether a national central bank, a prudent American corporation, or an American family concerned about preserving value and purchasing power - gold, silver, and platinum will see us through this period and can help us keep our finances (and our sanity) intact.