Deflation Looms for Overstocked Retailers as Household Wealth Shrinks

To the list of economic headaches plaguing consumers and retailers these days, consider an old truism: what goes up must come down.

The price of gas stings, but the auto manufacturing backlog caused by the pandemic means the car you’re fueling could (at the moment) be worth near or even more than what you paid for it. Average prices for used cars surged last year by nearly 30%.

Similarly, an affordable house in much of the US has been a unicorn. But for millions of long-term homeowners — especially the Boomers and Gen Xers — inflation has been a horn of plenty, adding more than $6 trillion in equity to owner-occupied housing, according to Federal Reserve data. That helped push the typical credit score for mortgage borrowers to a record-high in the fourth quarter of last year to 788.

Over the past two years — piled on top of federal stimulus payments — the average homeowner with a mortgage accumulated $67,000 in “tappable equity,” according to Black Knight, a mortgage market data cruncher. And tap they have.

This windfall cushion of paper wealth has emboldened consumers to keep spending in the face of rapidly rising prices for just about everything.

The most recent Commerce Department data shows that consumer outlays rose in April for the fourth month in a row.

That’s about to change. What went up is starting to come down.

Retailers caught with excess inventory — as Walmart and Target reported recently — will pay the price in heavy promotions, markdowns, and red ink. After more than a year of wrestling with problems like staffing and empty shelves…

Pricing strategy is about to take center stage.

In a deflating economy that seems inevitably headed into a recession, consumers will start pulling back. Among the first luxuries to go would appear to be online entertainment. Netflix, which had forecast first-quarter subscriber growth of 2.5 million, instead lost 200,000. According to streaming guide JustWatch.com, over the past year, Amazon’s Prime subscriber count has been sagging.

The first hint of what’s to come appeared in the most recent statistics on home sales. Redfin, a residential real estate web platform, reported that nearly one in five sellers cut their asking prices in the four weeks ended May 22, the highest rate since the fall of 2019, before the pandemic hit.

Redfin noted that other indicators of demand were down as well: Google “homes for sale” searches were 13% lower; mortgage purchase applications were 16% lower, and sales of new single-family homes in April were 16.6% lower than in March.

After a year in which home prices surged by nearly 20%, “The housing market has peaked,” according to Moody’s Analytics chief economist, Mark Zandi. “We will see price declines in a significant number of markets.”

The same trend is developing with autos. As manufacturers untangle problems with the supply of components, the market for used cars has begun to soften. According to Cox Automotive, its widely-followed Manheim Used Vehicle Value Index of wholesale prices has dropped by 6.4% from January through April. Retail sales of used cars declined in April from March by 13%.

Add to these mega-trends the first round of layoffs and hiring freezes in the tech industry, which had flourished during the pandemic.

In an economy that inspired the Great Resignation — where there have been more jobs than people willing to fill them — Facebook recently implemented a hiring freeze; Netflix said it was cutting 150 jobs; and Amazon said it had become overstaffed and would be closing a handful of distribution centers, potentially idling thousands of workers.

The Fed’s latest spending report noted that the savings rate has declined, suggesting that consumers are keeping the party going by robbing their piggy banks. It’s worth remembering that most economic downturns do not pivot on a dime, nor do they announce themselves in advance. It’s the steady drip-drip of bad news and shrinking asset values that accumulate until consumers realize that the old normal isn’t coming back and they better get used to the new one.

As for companies that need to plan for the future and not just REACT, there is a huge challenge (and potential) to get it wrong (or right). The risk is in playing it too safe, especially with high degrees of variability and outcome. So, what are these business leaders to do?

Well, given their historical behavior, it is likely most will miss the opportunity, react as quickly as they can and miss quarterly numbers as they report.

Can it be avoided?

I think the ability to “look around the corner” and see a bit of what is coming is easier than most think…they simply need to get out and talk to their customer bases, ask a lot of questions and listen intently to how “most” of their customers are planning for the future.

Just as importantly, they can “test” all of their assumptions on consumers using technology platforms to help them assess pricing, which is the most pressing problem for the coming months and quarters ahead.