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While big box stores won’t give the wealthy much sticker shock, the real threat is more subtle as the Fed runs out of room. The rich don’t shop a lot at Walmart so news that the gigantic big box is passing on Chinese import fees to retail customers shouldn’t cause immediate shudders. As far as your clients are probably concerned, the warning that prices are rolling up instead of down is more political gesture than anything else. The biggest retailer on the planet survives on keeping freight moving from Asian factories to U.S. stores. If they’re feeling the pressure of blanket 25% tariffs, they won’t suffer in silence. But warning that rank-and-file voters will taste the edge of those tariffs soon isn’t entirely a gesture. It’s a statement of fact. Either corporate importers are going to eat $50 billion in fees this year, directly reducing profitability, or it’s going to hit the mass market in the pocketbook and budgets will bend. And in the meantime the Fed remains alert and formally committed to crash the party. Here’s that inflationary shock Central bankers have been benignly amazed for years that historically low interest rates haven’t given inflation a fertile place to fester. Soaring global capacity and cheap imports ensured that the dollar could stretch, even when the cost of printing new dollars was close to zero. That dynamic has finally come close to resolving with inflation running around the Fed’s 2% target. That’s not a huge amount of buying power evaporating every year, but it’s a handy cushion against outright deflation. The Fed isn’t going to try to eliminate inflation entirely. However, the years of zero buying power erosion look like they’re over now. And if inflation slips its leash, the Fed is going to act as aggressively as it can to wrestle it back into its 2% box. Higher prices will feed the argument for higher interest rates. Even a few months ago, I would have said a global commodity shock was the only way inflation could spike like that. We’d need something like an oil embargo or dollar devaluation, and with the U.S. now a net energy exporter the embargo is unlikely to hurt. But this brings us back to Walmart, which plays a huge role in the middle-class landscape with $400 billion in U.S. sales last year out of an overall $4 trillion retail economy. While the entire Walmart basket isn’t dependent on China, maybe 25% of the company’s inventory originates in that country. If that merchandise is now 25% more expensive to import, that’s a 6% surcharge on the typical transaction and $25 billion draining out of household budgets. Over longer time periods, that surcharge gets factored into buying patterns. As a one-time event, however, it’s a 6% inflationary surge on the Walmart cart or a 0.6% bump in what consumers pay. And that 0.6% bump remains in the data for an entire year. Despite Walmart’s marketing message, prices are a lot harder to roll back than they are to raise. Once they go up, they stay there. When the Fed sees the CPI trending above 2.6% in the face of 2.5% overnight lending rates (at best), what will they do? In the meantime, wealthy families have already amassed a lot of buying power. The real value of those assets declines with inflation, even if they never step foot in a Walmart or similar store. Suddenly it’s inflation that their investments need to keep up with, not ambient interest rates. In a 2.6% year, that’s what their portfolio needs to deliver in order to break even, let alone earn money. It’s not a lot higher than Treasury yields, but even an 0.2% performance gap adds up to real dollars when you’re dealing with millions or billions. And we haven’t even mentioned the prospect that the first generation of post-tariff iPhones might end up costing an extra $250 before the factories shift to Taiwan or elsewhere. Rich people still buy iPhones. Tim Cook will eat a little cost inflation to keep them in his precious services ecosystem, but he also knows that his brand guarantees a lot of price elasticity. If they paid $999 for a phone last year, he can charge $1,250 this time around and not see his luxury market erode too much. Overseas customers are another story, but that’s more about export than bringing the phones to U.S. stores. Network impacts Meanwhile, every link in the consumption chain faces a tough choice: retain market share by absorbing import costs or risk losing sales in order to preserve profits. That’s already a choice U.S. companies are making across the board. Revenue is still climbing at a healthy rate. Profit has stalled. As more companies are confronted with import costs, at least a few will kick the pain up the chain to their customers. Step by step, the impact multiplies. Apple doesn’t just pay to bring in the phones. It pays component suppliers a little more. Pain on its margins increases. For Apple, where sales have already hit a wall, there’s no real incentive not to raise retail prices. Arguably Walmart tells a similar story from the opposite end of the market. Sales have already peaked as a percentage of overall U.S. retail. Amazon is on the offensive. Why not raise prices and preserve profit instead? I doubt it will make shareholders happy either way. But that’s a story everyone who watches the market already knows. It’s getting hard to squeeze performance out of stocks when margins are eroding. The investor class sees this. That’s what hurts, even before any one-two punch from inflation and interest rates hits. In the last few years we’ve seen consumption cool after a substantial market downswing. The tendency now is to blame it on people feeling less wealthy and so less inclined to write big checks. If the little checks at Walmart get a little bigger, Walmart shareholders do all right. But if people take a look at their Amazon Prime accounts and no longer see the value, the market is in trouble. Either way, a quick deal or at least a truce would be nice. Otherwise a lot of people now betting on lower interest rates and benign inflation a year from now are going to be disappointed. |
