Wentz Weekly Insights
Tough Week For Retail While S&P 500 Touches Bear Market Territory
Stocks have been in a downtrend, trying to figure out the uncertainties around inflation, the Fed and monetary policy, the spread of Covid, particularly in China but also in the US where cases are rising, geopolitical concerns over Russia, China, and Iran, and the upcoming Midterm elections. These issues together have caused a 19% drop in the S&P 500 since the highs on January 4, and briefly down 20% on Friday, a level corresponding to a bear market.
Additional weakness was triggered last week by earnings results from two key retailers – Walmart and Target. After reporting sales that were better than expected but profits that were below expectations, Walmart fell 11.4% for its worst day since 1987. Target also reported higher sales than expected but operating income that was much lower than consensus, leading to a 24.9% drop in shares and a 30% drop for the week. This led to a 9.4% decline in the Retail sector for the week and a 32% year-to-date decline.
But both of these declines were driven by things we already knew and issues we have been discussing for several months now. Even though Walmart posted better sales than expected, its profits disappointed, something management attributed to supply chain issues, higher wages, and shifts in spending. Something a bit more surprising was when executives said multiple times they were caught off guard by the magnitude of certain issues like the degree shoppers would cut spending in other categories to fund food purchases. Food prices are up almost 10% from a year ago.
Target made similar comments but faced more pressure on the bottom line – its net income was just over $1 billion, but down 50% from the year ago period and almost half a billion short of forecasts. Executives said supply chain and higher costs from freight and transportation (“hundreds of millions of dollars higher than our already elevated expectations”) weighed on profits. In addition, it saw a rapid slowdown in spending on discretionary items, those that tend to be higher margins, and a shift to more spending on staples and food. That trend is expected to continue and is reflected in the lower margin forecast. Its updated forecast sees margins of 6% for the full year, versus its previous forecast of 8%, a massive difference in a low margin business.
On the other hand, Home Depot had a solid quarter with results beating expectations and boosting its full year sales and profit guidance, noting its ability to effectively navigate the challenging environment of supply chain issues and higher costs.
In addition, retail sales grew for the fourth consecutive month, coming in higher than expected, but inflation plays a major part in that equation. Consumers are having to spend more to purchase the same amount of goods. April’s results reflect consumers are spending more, but the amount they are spending is all coming from higher prices. Retail sales were 8.2% higher from a year earlier with inflation (measured by the consumer price index) up 8.3% over the same time, reflecting a 0.1% decline in “real” retail sales.
The mixed results reflect the uncertainty investors are facing today. As consumers are being forced to spend more on needs due to higher prices, discretionary spending is going to decline. Fed Chairman Powell spoke on the issues last Tuesday and is expected to make another speech this Tuesday. It seems now every time he goes on the record the tone is more hawkish, using the Fed’s tool of forward guidance (influencing the behavior of individuals and businesses by what it says). The most recent speech reiterated the Fed’s stance on going past a neutral interest rate if necessary (a rate that neither stimulates nor destroys demand). The further the Fed goes past neutral the less likely it is to make a “soft landing.” However, it may be too late. The Fed made policy moves after inflation hit 40-year highs after months of insisting inflationary pressure were “transitory.” Now it is faced with the task of bringing that down without inducing a recession. The probability of a hard landing is rising and that calls for more defensive positioning.
Week in Review:
Stocks opened the week not being able to continue on Friday’s momentum. The roller coaster ride continued with stocks down at the open, going positive around mid-day before ultimately settling lower. Economic data out of China reported in the morning was weak as the country deals with COVID-related shutdowns. Moves were made to provide help to the economy including a reduction in mortgage lending rates as well as the gradual reduction in COVID restrictions. Defensive sectors were the only ones to finish in the green while value outperformed growth with the S&P 500 finishing down 0.39%.
It was a big week for retailers and Walmart kicked things off Tuesday reporting Q1 results that missed expectations due to labor issues and supply chain costs while cutting guidance, resulting in its worst day since 1987. On a more positive note, retail sales increased a better than expected 0.9% in April and were revised much higher for March. In addition, Chairman Powell spoke at a Wall Street Journal conference, reiterating past comments that inflation is too high in a more hawkish tone. Stocks managed to rally with small caps leading the way – the Russell 2000 was up 3.19% while the S&P 500 gained 2.02%. The rally could have started from news in China that there were three consecutive days of no new Covid cases in Shanghai, something that could ease its lockdowns.
A massive selloff hit markets Wednesday, the motivation for selling coming from Target’s earnings results that missed expectations, particularly the bottom line, due to “unexpectedly high costs” as well as lowering its 2022 operating income guidance substantially. The company also noted consumers’ shift in spending from high margin discretionary items to lower margin groceries and other staples. In addition, housing starts and permits came in slightly lower than expected. Stocks experienced one of their worst days since the early days of the pandemic. The S&P 500 fell 4.04%, Dow down 3.57%, and NASDAQ down 4.73%.
Jobless claims Thursday morning showed a slight uptick but remain near 40-year lows, while existing home sales fell slightly as expected as higher interest rates, low supply, and higher prices have slowed home sales in recent weeks. In addition, the Philly Fed manufacturing survey showed activity in the sector remains strong, although expanding at a slower pace in May than in April. Elsewhere, Congress approved $40 billion in aid to Ukraine, which now goes to President Biden’s desk for signing into law. Markets had yet another volatile day and sharp reversal. After seeing a mid-day rally, stocks finished mostly lower for the day. The S&P 500 finished down 0.58% while small caps rose with the Russell 2000 up 0.08%. Internals were not as bad as recent days with advancers leading decliners on the NYSE and NASDAQ.
On Friday, China’s central bank took another move to support its property sector by cutting its long-term lending rate by 15 basis points to 4.45% in an effort to reduce mortgage costs and improve loan demand. Iron ore moved higher, finishing with its first weekly gain of the past five. However, U.S. stocks struggled after opening slightly higher. The S&P 500 was as high as 1.1% shortly after the open before moving deep into the red and reaching bear market territory, down 2.2% at the lows. But once again stocks made a remarkable reversal, recovering all the losses and closing barely higher.
The 10-year US Treasury yield ultimately finished lower at 2.79% after beginning the week at 2.94% and briefly moving over 3% on Wednesday, with spreads on corporate bonds widening. Oil held steady for most of the week but moved slightly higher Friday to end the week 2.5% higher. US equities finished lower across the board with the S&P 500 logging its seventh consecutive weekly decline, the most since the dotcom bubble burst era of 2001, with the major indices finishing as follows: Russell 2000 -1.08%, Dow -2.90%, S&P 500 -3.05%, NASDAQ -3.82%.
Recent Economic Data
- The 30-year fixed mortgage rate averaged 5.25% for the week ended May 19, according to the Freddie Mac Primary Mortgage Survey. This is down from 5.30% the week prior, but higher than 3.0% a year ago.
- The Empire State manufacturing index, a survey of manufacturers in the New York region, was at -11.6 for May (negative reading reflects contracting activity), down substantially from 24.6 in April and 15.0 that was expected. New orders were down, shipments fell at the fastest pace since the early pandemic days, delivery times lengthened, and the labor market continued to improve.
- The Philly Fed manufacturing index, a survey of manufacturers in the Philadelphia region, was 2.6 for May, below 17.6 from April and 16.1 that was expected. Interestingly, because of the decline in the index, new orders and shipments rose while employment fell. Prices continue to rise at the fastest pace on record. The two reports were very mixed, but we will note one month does not make a trend. We will see what the PMI and ISM reports show in 2 weeks.
- The retail sales report for April was strong and data reflects consumers are spending more, but “real” consumption may not be that much higher. Nominal retail sales rose 0.9% in the month, slightly ahead of expectations. More impressively, March retail sales were revised up from 0.5% to a 1.4% increase. Excluding auto and gas sales, which tend to be two volatile segments, sales rose a strong 1.0%, almost doubling expectations, while March’s 0.2% increase was revised to 1.2%. Overall sales are 8.2% higher than a year ago. Adjusted for inflation, which rose at 8.3% in the month, “real” retail sales are down 0.1% from a year ago. Of the 13 categories, 9 rose with the largest from miscellaneous stores up 4.0% in the month, vehicles up 2.2%, and e-commerce sales up 2.1%, while gas stations and sporting goods stores saw small declines. Retail sales have remained strong, but it is becoming more apparent in recent months most of the increase is being driven by higher prices. In addition, when looking at the details of the report, spending is continuing to shift to services and away from goods.
- The number of construction starts on a new home was at a seasonally adjusted annualized rate of 1.724 million in April, in line with March’s pace but slightly lower than estimates. The number of permits to build a new home fell, as expected, to an annualized pace of 1.819 million. Starts are 14.6% higher than a year ago while permits are 3.1% higher. Housing starts have steadily risen since the pandemic, but are starting to show signs of peaking. Because home builders are still behind, we expect housing starts to remain near these levels for the remainder of the year.
- Unemployment claims for the week ended May 14 was 218,000, rising 21k from the prior week with the four-week average at 199,500. Continuing claims fell to 1.317 million, down 25k for another 52-year low. The four-week average was 1.362 million, also a 52-year low.
- Existing home sales fell for the third consecutive month in April to an annualized rate of 5.61 million, a drop of 2.4% which was in line with expectations. Compared to a year ago the sales pace was 6% lower. The National Association of Realtor’s chief economist said higher prices and mortgage rates have reduced activity in recent weeks, which has resulted in a slow improvement in supply. Inventory rose to 1.03 million units, or a 10.8% increase from March, however still down 10% from a year ago. Houses are still selling quickly, the average property was on the market for just 17 days in April, equal to the prior two months. The median home price is up 14.8% from a year ago to $391,200.
- Video game developer Electronic Arts is seeking a buyer or another company that is willing to merge with it, according to Puck. EA has reportedly held talks with several potential suitors, including Disney, Apple, Amazon, and Comcast. Talks were advanced with Disney and Comcast, but discussions with both fell through.
- The WSJ is reporting Apple has told some of its manufacturers that it wants to increase production of its products outside of China, citing the country’s strict anti-Covid policy among other reasons. The report says India and Vietnam were two locations the company is taking a closer look at. Over 90% of Apple products are currently manufactured in China.
- McDonald’s and Starbucks recently announced their decision to completely exit Russia. McDonald’s, with 850 restaurants in Russia, was the first global brand to fully exit. The company said it will incur a charge of $1.4 billion to exit. Starbucks has 130 locations and accounts for less than 1% of global revenue.
- Elon Musk said the deal to acquire Twitter cannot move forward until he gets further information on the percentage of fake accounts. Musk has questioned that 5% of activity comes from fake accounts and wants details on how it determines activity driven by fake accounts.
Did You Know…?
Bear Market Declines:
Non-recessionary bear markets average a decline of 24% (a bear market by definition is a price decline of 20% or more from recent highs) with an average time frame of about seven months. The current drawdown for the S&P 500 is 19% (as of Friday’s close) and has taken almost five months (the most recent high was January 4), while the drawdown for the NASDAQ is 29%. The bounce back is quicker; within 60 days of a bear market low, the index is 17% higher. We often use these stats to stress the importance of avoiding panic selling. Those that do almost always miss the best up days. It is one thing to get out of the market, but for those that do, it is even harder to get back in. For example, the S&P 500 has averaged a 7.47% annualized return since 2001, but if one missed the 10 best days that return was cut in half to average 3.35% annualized. Keep in mind that 70% of the time the best days occur within two weeks of the worst days.
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The Week Ahead
Retailers will remain in focus this week with several set to report quarterly results. Earnings season is nearing an end, but still at least 15 S&P 500 companies will report this week. Notable reports include Zoom Video on Monday, AutoZone, Best Buy, Ralph Lauren and Toll Brother on Tuesday, Dick’s Sporting Goods, Williams-Sonoma, Nvidia, and Snowflake on Wednesday, and Alibaba, Costco, Dollar General, Gap, Macy’s, Ulta Beauty, Dell, and Workday on Thursday. On the corporate side, in addition to earnings, there will be many investor day events and annual shareholder meetings (JP Morgan, Meta, Twitter, United Airlines, and Chevron, to name a few). The economic calendar includes new home sales on Tuesday where expectations are for a slight drop from March levels, followed by durable goods orders, a direct input to factory orders and reflects business investments, on Wednesday. Thursday will see the second revision on first quarter GDP (expected to be unchanged at a 1.4% contraction), weekly jobless claims, and pending home sales. Friday will wrap up the week with the report on personal income and consumer spending for April. Consensus sees a 0.6% increase in income and a 0.7% increase in consumption. There will be more Fed speak, with Chairman Powell speaking on Tuesday, along with the release of the Fed’s most recent meeting minutes on Wednesday.