Walmart price cuts? Bullwhip Effect predicts deflation in response to retailers’ rising inventories
Updated
Analysts are predicting that Big Short investor Michael Burry’s expectation of the Bullwhip Effect on the US economy could come true – but not necessarily on a widespread basis.
Burry, the investor featured in the movie Big Short, has warned that the Bullwhip Effect could drastically affect supply chains, resulting in much lower retail prices from big-box chains like Walmart and Target, and reduced interest rates.
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Whole supply chain impacted
The Bullwhip Efflect, felt throughout the supply chain, is similar to the action that occurs when a whip cracks, according to Investopedia.
Ultimately, Burry contends, that the Bullwhip Effect could prompt the US Federal Reserve (Fed) to reverse course on its aggressive monetary tightening policy and reduce interest rates.
“I do think the Fed will ease monetary policy in 2023 as the victory over inflation becomes clear,” Preston Caldwell, advisory firm Morningstar’s head of US economics, told Capital.com. “That is greatly owing to the unwinding of price spikes, which you could label a manifestation of the bullwhip effect.
“The increase in mortgage rates will be sufficient to provoke a sharp housing downturn. GDP should narrowly avoid a recession, but it will be incumbent on the Fed to begin [an] easing policy – some combination of rate cuts and a pause in long-term asset sales – in 2023 in order to avert a larger downturn and reaccelerate GDP growth.”
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Demand shifting
The current Bullwhip Effect stems from shifting consumer demand brought on by the easing of COVID-19 restrictions and a reduction shipping bottlenecks that occurred last summer due to the global chip shortage and other factors.
The pandemic sparked demand for consumer goods, such as computers and electronics, and prices drastically increased.
But supplies that were stuck in transit in 2021 have come to market – along with more recent orders. Meanhile, consumer tastes have shifted towards services like travel and restaurants.
The widespread oversupply has raised investor concerns that prices could collapse, causing a recession.
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Rate hike expected
The Fed is expected to increase its benchmark interest rate by 75 basis points (bps) at its upcoming Federal Open Market Committee (FOMC) meeting. Caldwell said he will defer to futures markets’ outlook on interest rates, which show that a 75-bps hike is more likely than a 100-bps increase.
Mornginstar expects inflation to “fall dramatically” after peaking at 5.7% in 2022, said Caldwell. The company expects consumer price expenditures (CPE) inflation to drop to 1.4% between 2023 and 2026.
“We think most of the sources of today’s high inflation will abate – and even unwind in impact – over the next few years,” he said. “The spike in durable goods prices should recede as the semiconductor shortage and other issues are resolved. Likewise, energy prices will fall as supply makes up for the hit to Russian oil and gas production.”
Price cuts will be ‘nuanced’
The oversupply situation’s impact on retail price cuts will be “more nuanced” rather than across the board, David Sekera, Morningstar’s chief US market strategist, told Capital.com. That’s because “pricing is one of the most difficult and important aspects of success and failure in the retail industry.”
“Looking forward, the convergence of inflation, softening demand for goods, and supply-chain disruptions will make pricing extremely challenging,” he said. “We expect that the effects on pricing will vary by category, particularly in areas where lead times remain elevated and customers alter their shopping behavior to quickly adjust to increasingly uncertain economic conditions.
“During these times of heightened volatility, it’s harder to predict demand, and that can create over- or undersupply conditions that compel pricing actions.”
‘Way too much inventory’
In some categories, there is “way too much inventory” at a time when demand is more sluggish, Neil Saunders, GlobalData’s managing director of retail, told Capital.com.
“Retailers are discounting, and will continue to discount, to clear down excess stock,”’ said Saunders. “I expect this pattern to remain in place until inventory is rebalanced. Retail is also very competitive with retailers vying for market share, which helps keep a lid on price increases. T
Inflation to remain hefty
“That said, not all product will be discounted and in some categories, like grocery, hefty inflation will remain the predominant trend.”
Although overall inflation is up and prices are rising, he expects the pace of prices to moderate through the summer and into fall.
“I also expect retailers to absorb inflation, which will hit their margins, rather than passing it all across to consumers,” said Saunders. “A lot will also depend on the state of demand.
Consumer not cutting back
“At present the consumer is still spending and, despite being less confident, is not cutting back in a dramatic fashion. If demand turns very negative, then we could see prices come down fairly quickly in response as retailers try to trim demand.”
Given high US inflation numbers posted in June, he expects the Fed to increase interest rates “solidly” when the FOMC meets. While rates could increase in the short term, the Fed also needs to “remain flexible” because inflation could fall quickly and economic growth may stall. Against that dynamic, the economic could contract more sharply, he added.
“The Fed has to pull off a real balancing act here and it needs to show it is in front of events rather than behind the curve – which, over the past year, it seems to have been,” said Saunders.
Could retail stocks fall?
Bullwhip Effect theory also calls for public retail companies’ stock prices to fall. Morningstar’s Sekera said he could not comment on short-term impacts, because the company takes a long-term view on its investments in the stock market.
But, he noted Morningstar gives Walmart a three-star rating. And, the stock is trading at a slight discount to Morningstar’s $138 fair value assessment.
“Target is currently undervalued and is rated four stars, as the market price is below our $166 fair value,” said Sekera.
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