Why goods spending isn’t falling

Good morning. Stock volatility has been low lately. Are investors no longer scared of rate rises or bank failures? Nope, says JPMorgan, which blames calm markets on a technical to-and-fro between short-dated options sellers and systematic funds. There is plenty of fear around, it’s just not showing up in price movements. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Maybe goods consumption is just higher now

There is an enigma at the centre of the US economy: what’s up with goods spending?

The conventional story is well known. Fearing a pandemic depression, Congress and the Federal Reserve unleashed enormous fiscal and monetary stimulus. Everyone was afraid of in-person services businesses, so all that money flooded into the goods sector. At the peak, in March 2021, inflation-adjusted goods consumption had shot up 21 per cent from pre-pandemic levels, and goods inflation wasn’t far behind. This, though, was transitory. Eventually everyone had their fill of buying dressers and air fryers. Much ink was spilled about the great goods-to-services rotation: goods spending should return to trend as services spending rises. In the last year or so, it’s been all about inflation and spending in services.

But what if that’s wrong? What if real goods spending never falls back to its pre-pandemic trend, but instead plateaus at a higher level? It’s now been three years since lockdowns began and any trend-reversion is hard to spot:

In a note to clients published on Sunday, Spencer Hill of Goldman Sachs argues that something has changed. “Sustainably stronger consumer finances” have created fresh spending power for people at the bottom of the income distribution. After adjusting for composition effects, Hill estimates that real wage levels for the bottom 50 per cent of earners were 6.2 per cent higher in the first quarter of this year than in 2019 — and 9.6 per cent higher than in 2017. That implies something like $150bn per year in additional spending power for the bottom half. The number rises to $250bn once you throw in other disposable income sources such as social security payments.

This matters for two reasons: lower-income consumers spend more of each extra dollar earned, and they spend more of each extra dollar earned on goods, specifically. So long as bottom-half consumers have money to spend, goods consumption should stay high.

Is it sustainable, though? Comparing detailed (but less timely) consumer survey data for 2021 to 2019, Hill argues that it is. Consumer financial distress looks muted by historical standards. More than $1tn in excess savings is still out there. On top of that:

While the $1.6tn increase in consumer goods spending over three years is enormous in absolute terms, it may indeed be sustainable in the context of the $3.3tn rise in disposable income and the proportionately smaller spending increases for services categories on net. The increase in goods spending also does not look as outsized when one considers the strong disposable income growth of the bottom 3-4 income quintiles — recall that [government] data imply a high marginal propensity to consume goods for lower- and middle-income consumers.

In other words, consumers are broadly spending no more than what they’re earning. After stripping out certain (misleading) imputed costs, Hill finds that nominal spending has risen by $3.5tn and nominal income by $3.3tn:

We’ve spent time laying out Hill’s argument because it highlights an important point: the distribution of post-pandemic income gains has macroeconomic implications. If he is right, we’d expect both growth and inflation to be stickier — sharpening the policy trade-off the Fed faces. We’ll have more to say tomorrow, but as a first pass, his case fits with other research finding that inequality hurts demand. This is in part because the rich mostly save their money, and in part because such a “savings glut of the rich” is linked to burdensome consumer debts. That curtailing inequality juices demand seems not too far a leap. (Ethan Wu)

Bed Bath & Buybacks

After yesterday’s piece about the collapse of Bed Bath & Beyond, a reader, David Giudicelli, wrote to point out that I had missed an important point. In the decade running up to its collapse, the company spent billions buying back its own shares. This huge investment, in bankruptcy, will fall to roughly zero.

The numbers are eye-watering. Bed Bath & Beyond spent $11.7bn in buybacks between 2004 and 2021. For context, over that period the company’s free cash flow was $9.6bn. It spent all the cash profit it generated after capital expenditures, and more, buying back its own equity. Here is a chart:

In a limited sense, the buyback worked: the company’s share count fell by two-thirds between 2004 and the beginning of last year. And this meant that for a crucial few years, while Bed Bath & Beyond’s profits (dark blue columns) were beginning to fall, its profit per share (light blue columns) continued to grow, at least a little:

It was precisely in those years (2012-15), that Bed Bath & Beyond’s share price was at its peak. Revenue was decelerating rapidly, net income was shrinking, but earnings per share were rising because of the aggressive buybacks.

(The spasmodic price movement at the right side of the stock chart are a souvenir from Bed Bath & Beyond’s wild years as a meme stock).

Starting in 2016, per-share earnings started to fall, too. The stock followed suit. But the buybacks continued. In 2017, a year in which the company bought back half a billion dollars in stock, the shares must have looked cheap. The price/earnings multiple had fallen below 10, low enough to make the returns from buybacks look very attractive when measured in terms of the effect on the share count and therefore on earnings per share:

Cheap as the shares looked, buybacks were of course an awful use of the company’s money. Commercially, Bed Bath & Beyond was getting its ass handed to it in 2017; operating profit fell by a fifth that year. The shares were not undervalued.

Why did the management and board of the company spend all its extra cash on buybacks when operational problems were looming larger and larger? It is worth looking at their incentives. Its proxy statement for the fiscal year that ended in March 2015 — the year buybacks peaked, at $2.2bn — describes how the size of equity bonuses were determined by the company’s operating margin and return on invested capital relative to peers. Most of the weight was placed on the former.

While it is possible to lift ROIC by buying back shares (it reduces the denominator of the ratio so long as new debt is not issued to fund the purchases), buybacks don’t help operating margin. They might hurt it, if money is spent on shares that might otherwise be invested in operations. But the fact is that most of the pay of the board and executives, however it was determined, came in the form of shares that vest over a period of three to four years. They had good reason to get the share price up, and soonish. And for a couple of years at Bed Bath & Beyond, buybacks did seem to support the shares, even as revenue growth disappeared and profits fell.

The board and management had incentives, in other words, to spend the company’s resources in a foolhardy way, contributing to its bankruptcy. If you wanted to make the case that paying company leadership in stock does not align their interests with those of long-term shareholders, Bed Bath & Beyond would be a pretty good place to start. The basic problem, at the company and elsewhere, may be simple: the amount of time it takes for share compensation to vest (five years at the very longest) and indeed the tenure of a modern chief executive (seven years or so) are shorter than the amount of time strategic capital allocation decisions take to play out.

Companies are run to maximise executive wealth; this wealth is largely determined by short-to-medium term share price movements, not long-term corporate profitability. Most of the time, this misalignment is not too consequential. But along the way, you get some Bed Bath-type breakdowns.

One good read

Now that it’s over, what was Tucker Carlson’s show? One answer: “The latest and greatest in a hallowed American tradition of carnival barkers and hustling self-promoters who had a showman’s eye for the outré and grotesque and outrageous.”