Weak July retail sales have raised the risks of the U.S. economy sliding into stagflation, taking Wall Street on a wild ride.
According to the U.S. Census Bureau, retail sales — a measure of how much consumers spend at stores, restaurants, and online — declined 1.1% last month. That’s far worse than the 0.3% decline markets expected and a significant reversal from a revised 0.7% growth in June.
What Drives the Decline
One reason for the notable decline in July retail sales is a shift in consumer spending from commodities to services as the economy reopened from the COVID-19 lockdowns. For instance, sales of food & beverages dropped 0.7%, furniture sales fell 0.6%, and clothing sales sank 2.6%.
The retail sales statistics count what consumers spend on goods and some services, but they don’t measure expenditures on services such as entertainment, recreation, and traveling. These are the sectors that have benefited the most from the reopening of the economy.
Another reason for the retail sales decline is the ongoing semiconductor shortage. It has constrained automobile production and sales. As a result, sales of motor vehicles and parts dropped 3.9%.
There’s also Amazon pulling forward Prime Day to June from July, contributing to a 3.1% decline in online sales.
Fears of Stagflation
A significant decline in retail sales usually has a positive side effect; it helps pull down inflation. But that’s not the case if inflation is caused by supply-side bottlenecks, as has been the case lately.
This has raised fears on Wall Street of the return of stagflation, a situation of an economic slowdown that coexists with rising inflation, similar to the situation back in the mid-1970s and the early 1980s.
Stagflation complicates the job of the Fed, as it must attempt to achieve two goals at once: bring inflation down, while trying to stimulate the economy.
Conventional and non-conventional monetary policy cannot accomplish both. So, the Fed must make a tough choice between raising interest rates to fight inflation, and risk turning an economic slowdown into a recession, or keep interest rates low, and risk runaway inflation.
Stagflation complicates the situation on Wall Street, too.
On the one side, a weakening economy hits listed companies hard in what equity analysts pay most attention to, the top line. The reason is simple: what people spend on buying things becomes revenue to companies that sell them. So, the less customers spend, the less money flows to the top lines of listed companies.
On the other side, rising inflation leaves Wall Street guessing which way the Fed will go on interest rates. It means higher uncertainty and lower equity prices across the board.
Summary and Conclusions
Fears of stagflation, the coexistence of rising inflation, and a slowing economy resurfaced on Wall Street lately, following a couple of reports showing that prices of goods and services are climbing as retail sales are falling.
That’s not a good development for equities. On the contrary, it makes listed companies less profitable and alternative investments more appealing, the right mix for sell-offs.
