For the segment of American society squeezed by surging prices and the wind-down of pandemic financial support, it’s getting tougher to spend — even at discount retailers.
Wall Street has noticed.
In the options world, where derivatives dealers set the cost of insurance against stock plunges, traders are bracing for more consumer belt tightening. Prices for bearish options on stocks of discount-retailers Ollie’s Bargain Outlet and Dollar General as well as fast-food chains like McDonald’s have begun to soar.
These firms are “more leveraged to that low-end consumer than they would be to your middle-income or higher-end consumer,” Amy Wu Silverman of RBC Capital Markets said on Bloomberg TV and Radio last week. “The options market is starting to flag that concern to the downside.”
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More Americans are having a harder time making ends meet. Consumer prices surged in January, sending the annual inflation rate to a four-decade high. Rents are skyrocketing. The government’s pandemic financial support has largely dried up, and expanded unemployment benefits ended last summer. The child tax credit — worth up to $300 per child per month — saw its
So the price of protection for bargain retailers’ shares is rising. According to Silverman and data compiled by Bloomberg, three-month puts betting on a 10% decline in Dollar General are now 5 points above calls wagering on a comparable increase, a fattening of “skew” that signals bears are getting the upper hand. Similarly, the spread between one-month puts and calls for Ollie’s widened to 12 points last week before retreating.
Silverman is tracking the same trends for fast-food chains like McDonald’s, Jack in the Box and Yum! Brands, parent of KFC, Taco Bell and Pizza Hut. Protection against plunges for delivery services like DoorDash are also getting more expensive.
Yet the signals sent by their shares are by no means clear, as many factors can affect prices. Walmart's market fortunes have long been viewed by many as a contrarian signal for growth — the better it does, the worse off consumers must be. Though Dollar General’s shares are down 15% on the year and Ollie’s has fallen 12% in the same period, strapped shoppers in search of deeper discounts could end up adding to discounters’ bottom lines.
And calculating how much broad economic trends weigh on individual stocks can be risky. Anthony Chukumba, a managing director at Loop Capital Markets who covers Ollie’s, says stores like it are more exposed to supply-chain disruptions than other brands, which may explain trader skittishness.
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Even the impact of inflation is far from obvious. Dollar Tree, for example, said in November that it would raise standard prices to $1.25, edging away from the price strategy that gave it its name.
“Companies like Dollar General, Dollar Tree, they’re going to benefit,” Chukumba said in an interview. “They’ve been raising prices, just like everybody else.”
Inflation isn’t the only problem for consumers. RBC’s chief economist Tom Porcelli has been tracking so-called liquid assets, which include checking and savings accounts. The lowest-income quintile of the population now has liquid assets below pre-COVID levels as “prior government largess is fading,” he wrote in a note. Porcelli also says that while the lowest-paying jobs saw strong wage gains relative to high-paying positions through most of last year, this will fade as job openings slow.
The disappearing ability to overspend will alone slow overall economic growth, Porcelli said.
Higher prices mean consumer confidence “remains in the tank,” according to Morgan Stanley strategists including Mike Wilson. Inflation in necessities is eating into disposable income and the team projects that spending on durables, electronics, as well as travel and leisure is expected to decline for lower-income cohorts.
A survey by the bank found that consumers on the lower end of the income spectrum have a more negative outlook on their financial situation over the next six months.
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Consumer pessimism is resonating beyond discount stores. Matt Stucky, senior portfolio manager of equities at Northwestern Mutual Wealth Management Company, points to PayPal , which recently said it had a slower-than-expected finish to 2021, driven partly by a pullback in spending by lower-income consumers.
Such companies are “talking about specific weakness with the lower-income consumer because of inflation, because of what’s happening with gas prices, with rent, with grocery prices,” Stucky said by phone.
Cheryl Smith, economist and portfolio manager for Trillium Asset Management, said that Washington is also mindful of the effects of constrained consumer spending, since “people in the lowest income quintile have been the cushion that’s been used to make the rest of the economy run.”
“It explains quite a bit of the political concern about the impact of inflation,” she said.
—With assistance from Lu Wang
