Investors Jolted As U.S. Retailers Show Inflation Hitting Consumers

Evidence of red-hot inflation seeping into the American economy is sending a chill through investors after major U.S. retailers reported people are cutting back on buying bigger-ticket items as they just try to get by.

Investors wiped almost 25% off Target shares on Wednesday after its profit halved, and it fell another 3.2% on Thursday morning. Walmart was down 1.3% Thursday after already falling more than 17% in the two sessions after it reported weak results early on Tuesday.

Target's earnings showed consumers spending more on food and household essentials instead of high-margin discretionary items, while Walmart showed shoppers had moved to buy lower-margin basics.

On Thursday, Kohl's was up 1.1% after falling 11% on Wednesday as the department store company cut its full-year earnings forecast, warning that red-hot inflation is starting to erode profit margins and consumer spending.

BJ's Wholesale Club, which fell 16% on Wednesday, was up 10.7% on Thursday after it beat Q1 financial expectations, saying membership rose as customers searched for value due to soaring prices.

On Tuesday, Federal Reserve Chair Jerome Powell pledged the U.S. central bank would raise interest rates as high as needed to kill the surge in inflation.

The S&P 500 was last down 0.2%, leaving it down 18% year-to-date and 18.6% below its Jan. 3 record close, after closing down 4% in Wednesday's broad sell-off. [.N]

"Retailers are starting to reveal the impact of eroding consumer purchasing power," Paul Christopher, head of global market strategy at Wells Fargo Investment Institute, said on Wednesday after his firm forecast a mild recession around year-end into early 2023.

"The consumer's ability to spend is eroding at a faster pace than it was a month or two ago. We think that pace is going to accelerate further," he said.

The S&P 500's consumer discretionary index bounced back slightly, last up 0.9% after losing 6.6% on Wednesday in its deepest one-day sell-off since March 2020 and was still off more than 30% year-to-date, putting it on track for its weakest year since 2008.

Cantor Fitzgerald said it was unwinding its expectation for a short-term bounce in equities and that if there is a lift, it would likely be shallow and "not worth playing."

"The (Wal-Mart/Target) numbers are very concerning as they show the consumer is reducing discretionary purchases while company margins return to pre-pandemic levels," said Eric Johnston, head of equity derivatives and cross asset at Cantor Fitzgerald.

While investors have been worried for some time about inflation, the latest results pile on worries about the impact of inflation on the consumer, said Ryan Detrick, chief market strategist at LPL Financial.

However, the sell-off came the day after data showing U.S. retail sales rose strongly in April as consumers bought more motor vehicles amid supply improvements along with increased spending at restaurants despite high inflation, souring consumer sentiment and rising interest rates.

Cliff Hodge, chief investment officer at Cornerstone Wealth, said the narrative was "shifting from inflation scare to recession scare."

Chuck Carlson, chief executive officer at Horizon Investment Services, said retailer results appeared to be potentially "one more indication of perhaps a slowdown in the economy."

"I just wonder if people are starting to really get pinched by fuel costs - both businesses as well as consumers. ... When you are paying north of $5 for a gallon of gas, that's a hammer and that's a hammer on everybody," Carlson said.