A forecasting miss derails Walmart and Target

This week management at Target and Walmart reported the worst earnings in recent memory, sending both stocks spiraling down. Shares of Target fell by 25%, while Walmart dropped by 11%.

Despite the shock, the news may be a decent sign for the American economy, as the primary culprit is an abrupt shift in consumer demand. The COVID-19 pandemic shifted consumer spending from services to goods as consumers dealt with lockdowns and quarantines. Many have argued that the resulting demand caused an onslaught of inflation by overloading an already fragile system. In the process, it enriched established retailers.

Established retailers had the capital to accelerate a shift towards omnichannel retailing, allowing consumers to place orders online and receive the goods through pick-up or delivery. Smaller retailers weren’t so lucky. According to research by the Federal Reserve, the majority of COVID-era retailer bankruptcies were very small retailers with assets of under $95,000.

Meanwhile, large retailers flourished.

However, this era of outsized retailer profit may be ending. After 2+ years of concentrated buying, consumers finally shifted from goods and back into services.

Here’s Brian Cornwell, Target’s CEO, talking about the switch on this week’s earnings call:

While we anticipated a post-stimulus slowdown in these categories and we expect the consumer to continue refocusing their spending away from goods and into services, we didn’t anticipate the magnitude of that shift. As I mentioned earlier, this led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs and outdoor furniture.

While it is understandable, a forecasting miss is driving the inventory issue and the resulting markdowns. Forecasting is hard in typical years; translating demand forecasting signals into inventory is almost impossible during COVID. Everyone knew the bubble would pop, but it was essentially impossible to predict when. The result is that most retailers are carrying excess inventory. Target estimates that markdowns accounted for about 3% of its operating margin decline.

The table below shows Walmart and Target’s inventory days. The metric looks at the time…