When Walmart Gets Generous: The Coming Wage Inflation.

On February 19, the CEO of Walmart sent shockwaves through the private sector by announcing that, beginning in April, Walmart will raise its minimum wage to $9 per hour, and raise it again to $10 per hour in 2016. With 1.3 million employees, Walmart is the country’s largest private sector employer.

This move has recently been duplicated by TJX Companies, parent of TJ Max, HomeGoods and Marshall’s. Given that retail is a fiercely competitive business, one may ask: what accounts for Walmart’s (and TJX’s) sudden act of generosity?

For starters, Walmart is trying to improve its image. According to a poll taken by the American Customer Satisfaction Index, Walmart placed last among twelve retail chains for customer satisfaction. Nordstrom was first at 86 percent satisfied, Target tied for third at 80, and Walmart brought up the rear at 68. From the results of this survey, Walmart has been called the most hated retailer in America.

Not being well-liked has its problems. The domestic Walmart division, the company’s largest, has had stagnant sales for four years. Sam’s Club is only marginally profitable compared to Costco, where average wages are $20 per hour. At Walmart, staff turnover is an incredible 44 percent per year. At Costco, the number is 17 percent, falling to 6 percent for workers on the job more than one year. So low are Walmart’s wages, that its employees received $2.66 Billion of food stamps and other forms of federal assistance, so far did their wages put them under the poverty line. The proposed wage increases will eliminate some but not all of this worker subsidy, paid for by the American public in the form of taxes or government deficits.

A second problem is that almost half of Walmart’s hourly employees are part- time. Because of their part-time status, they do not qualify for medical or retirement benefits. This puts them disproportionately behind their full-time counterparts, both at Walmart and elsewhere.

Caught in the cross-fire of low wages and hours is the store manager. Unlike Costco, the store manager at Walmart has no say as to merchandise selection, quantity or display. Excluded from the revenue side of the ledger by the home office, the only thing they can control is expenses, specifically labor. Thus, they are obsessed with reducing labor costs by using part-timers, turning staff over before they qualify for benefits, and the like.

Since Walmart tracks profits by store, the result is a system that is alternately described as Darwinian or Draconian. This creates outcomes like some stores holding a “Walmart Employee Food Drive” at Thanksgiving last year to collect food for the Walmart employees themselves. In other words, Walmart workers could not afford to feed their families by shopping at their own stores. Jonathan Swift could not have come up with this kind of thing.

Thus, for Walmart and others, the decision to raise wages is not so much an act of generosity as a concession to several realities. As stores like Costco have shown, better- paid employees cost less in the long run (through lower turnover), and lead to a more satisfying customer experience to boot.

Another reality is that the labor market is getting tighter than the statistics suggest. Given its reams of employee data, Walmart has most likely tracked the decline in worker productivity as the purchasing power of the minimum wage has been eroded by inflation. Less productive workers mean that, either more have to be hired to do the original task, or shoppers leave to find competent and cheerful sales help elsewhere.

A third reality is that, the title of “America’s Corporate Welfare Queen” does not sit well with the company, which along with McDonald’s, shares this distinction. An overhaul of the tax code with an emphasis on simplification would make the government’s subsidy of Walmart workers even more stark. Better to deal with this now rather than later.

For investors the issue is: what does Walmart’s decision say about the investment environment? In essence, it says that we are closer to full employment than many, including policymakers, want to believe. It has long been our contention that due to the demographic shifts in the labor market, brought on in part from the restrictions on immigration since 2001, the pool of competent and trained workers is smaller than the data suggests. If this is true, the acceleration in wage expenses will be a major factor in contracting corporate profitability going forward.

Higher wages, in itself, need not be a bad thing for everyone. As wages make up about 70 percent of Gross Domestic Product (GDP), higher wages means that the economic expansion should remain intact. It does mean that, for companies which have a major labor component in their price structure, profit margins will probably narrow. Since corporate profits as a percent of revenues is currently at a record high, this can be seen as less of a negative and more of a regression to the mean.

The Economy

Economic activity seems strong, but the crosscurrents from the collapse in oil prices have yet to sort themselves out. There are reports that some of the Middle East Countries want to reduce output to increase prices, but these accounts have not been credibly substantiated.

Add to the muddle the effects of the multiple winter storms that have assaulted much of the country, especially the Northeast and Midwest. While freezing temperatures may help to refute global warming, it does little for economic statistics, which will be a mess for the first quarter as the result of the multiple shutdowns.

Interest Rates

The latest Federal testimony has reinforced the notion that interest rates will be raised sometime around mid-year. The extent and timing of the increase is still up in the air, but a quarter or half point increase this summer seems to be what the markets are expecting.

In tandem with the increase in short-term rates is the running off of the Treasury’s bond portfolio, described here previously. Such a move would increase rates at both the long and short end of the yield spectrum. This will help to prevent a situation in which short-term rates are higher than long-term rates, a sign by some of an impending recession.

Inflation

The wage increases by Walmart and others will be inflationary, although how much so remains to be seen. The strong dollar is making imported goods more competitive, and the resolution of the dockworkers strike will make such goods more available. While such competition helps insulate consumers from the full effects of wage increases, it adds to the misery of domestic producers who are limited in passing on the higher costs of labor.

The Stock Market

Stocks are currently trading at all-time highs, based on various indexes. They are also trading on a great deal of complacency and optimism, fueled with abundant and cheap money.

There seems to be a belief that nothing can go wrong with the market. This usually sets the stage for some kind of unpleasant surprise. While the longer-term case is intact, the short-term case of everyone who invests makes money, and the riskier the investment the more made, has yet to be tested. When it is, there will be the usual crop of winners and losers. The winners will recover. The losers will disappear.

Warren M. Barnett, CFA February 27, 2015 

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Warren Barnett

Warren Barnett is the founder and President, and Portfolio Manager for Barnett & Company. He was associated with the investment banking firm of Kidder, Peabody & Company and the investment counseling firm of Davidge & Company in Washington before returning to Chattanooga to accept a position in the trust department of a local bank. Perceiving the local need for the type of firms with which he was associated in Washington, he established Barnett & Company in 1983. He obtained the Chartered Financial Analyst professional designation from the Institute of Chartered Financial Analysts, Charlottesville, Virginia in 1986. Mr. Barnett graduated from The McCallie School in Chattanooga. He received his Bachelor of Science degree in Accounting from the University of Tennessee at Knoxville and his Master of Business Administration degree in Finance from the Owen School of Management at Vanderbilt University.
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