Wentz Weekly Insights
Wages & Retail Sales Are Higher But “Real” Wages & Sales Are Declining
Defensive names outperformed and growth underperformed last week as higher rates continue to be a headwind for stocks, particularly higher growth stocks. The yield curve has steepened after the 2- and 10-year rates inverted several weeks ago, thanks to a 70 basis point (one basis point equals one hundredth of one percent) increase in the 10-year yield to 2.83% (as of Thursday’s close). The Federal Open Market Committee (FOMC) meeting minutes revealed the extent of the quantitative tightening, or the Fed shrinking its balance sheet at a rate of $95 billion per month, helping push up longer dated yields since.
Two tailwinds for stocks the past two years – the Fed with ultra-low interest rates and inflation essentially non-existent – have now become headwinds. Fed Governor Christopher Waller was the latest to speak last week on the Fed’s path and its consequences on the U.S. economy. He said the Fed is doing what it can to avoid damaging the economy from tighter policy but said “when you have to use a brute-force tool, sometimes there’s some collateral damage that happens.” He went on to say the “tricky part” will be if the FOMC can raise rates enough to slow inflation without causing problems in areas such as employment and production.
With inflation so high, real wages and real retail sales have turned negative in recent months. Wages and salaries, derived from the personal income report, were up an annualized 9.6% in February, and the Department of Labor’s March employment report shows average wages were up 5.6% in March compared to a year ago. Even though wages are rising at a higher rate than normal, consumers are no better off. After adjusting for inflation, wages are still down 2.9% from a year earlier. Retail sales for March, numbers that were released last week, showed a 0.5% increase in the month, and 6.9% increase from a year ago, but adjusting for inflation real sales were down 0.7% in March and down 1.6% from a year earlier.
When assessing future inflation a key input is consumers’ expectations. The Federal Reserve Bank of New York, through its monthly survey, said consumer’s inflation expectations have been drifting higher. In March, consumers expected inflation over the next year to be 6.6%, up from 6.0% the month prior. Looking at the medium-term, consumers still expect high inflation. The survey showed inflation 3 year from now is expected to be 3.7%, almost double the Fed’s longer-term target of 2%. If people expect higher prices, that could exacerbate the issue.
The key question for markets over the next several weeks is how companies are handling the inflation situation. As mentioned last week, the focus this earnings season will be on guidance and what executives are saying about higher prices. Margins have maintained relatively high levels, but that has a high risk of coming down if companies either cannot control costs or cannot pass higher costs to consumers through higher prices. Lower margins would mean lower profits, and lower profits means lower stock valuations, and that uncertainty is another reason we expect continued volatility through this quarter’s earnings over the next several weeks. As such, we maintain our stance on favoring more defensive positions.
Week in Review:
The holiday shortened week opened with growth stocks continuing to be under pressure as bond yields continued to rise. All sectors were down on the day, with energy down the most despite a 4% drop in crude oil, while tech was down 2.6%. The S&P 500 closed near the lows, down 1.69%, while the NASDAQ fell 2.18%. Stocks got a boost Tuesday morning after the consumer inflation report came in meeting expectations. The consumer price index rose 1.2% in the month, driven by gasoline prices, and was 8.5% higher from a year ago, both near expectations, leading to investors believing we are near a “peak” in inflation. The fact is inflation is high and will continue to remain high through 2022. The thought of a peak was a relief and markets moved higher as a result with yields moving slightly lower. However, the gains were short lived as indices moved lower with all expect small caps and the S&P 500 finishing down 0.34%. Producer prices Wednesday morning showed another record high with a 1.4% monthly increase and 11.2% increase from a year ago. Earnings began to roll in with Delta having its best bookings on record and saying it recorded a profit in March, while JP Morgan missed estimates with CEO Jamie Dimon saying there are challenges ahead due to inflation, supply chain issues, and geopolitical concerns. Stocks were able to open higher and build momentum to close near the highs of the day. Growth stocks were outperformers with the NASDAQ up 2.03% while the S&P 500 gained 1.12%. It was a quiet day on Thursday to close out the week with defensive names performing the best for the day and the rest of the market lower. Jobless claims remained below 200,000 for the latest week while retail sales rose a more than expected 0.5%. Tech and growth were the big underperformers with the NASDAQ down 2.14% while the Dow was down just 0.33%. For the week crude oil moved 9% higher and back over $100/barrel to $107/barrel, the 10-year U.S. Treasury yield moved from 2.72% to 2.83%, with the move higher a headwind to stocks as the major U.S. stock indices finished as follows: Russell 2000 +0.52%, Dow -0.78%, S&P 500 -2.13%, and NASDAQ -2.63%.
Recent Economic Data
- Consumer prices increased 1.2% in March, as measured by the consumer price index, slightly ahead of the 1.1% increase expected. A 18.3% increase in gas prices in March accounted for half the monthly increase, while the also important food prices rose 1.5%. Excluding the volatile food and energy categories, consumer prices were up 0.3% in the month, with the shelter index by far the biggest driver of the core increase, up 0.6% in the month. Price increases were broad with airline fares, furniture, medical care, and insurance all contributing, while one of the only declines was a 3.8% drop in used car prices (however are still up 35.3% from a year ago). Compared to a year ago the all item index accelerated to an 8.5% year-over-year rate, the highest since 1981, while the core index (excludes food and energy) was up 6.5%, the highest since 1982. Numbers were all around expectations, breaking a trend where inflation consistently came in higher than expected. This report doesn’t change anything, inflation is still high and will continue to be above the Fed’s target.
- Producer prices rose 1.4% in March, according to the producer price index, unlike the CPI report was higher than expected by 0.3%, while core prices were double expectations with a 1.0% increase. Producer prices through the first three months of 2022 are increasing at a 14% annual rate. The increase in March was driven by a 5.7% increase in energy and 13.5% increase in food. Compared to a year ago prices were up 11.2% at the headline level and 9.2% for core prices, both the highest since data began.
- Prices for U.S. imports rose 2.6% in March for the largest monthly increase since 2011, after a 1.6% and 2.0% increase the prior two months, driven by a 14.6% increase in fuel imports. Prices for imports are 12.5% higher compared to a year ago. Prices for goods and services exported from the U.S. rose 4.5% in March, the highest since data started in 1989, and follows previous records of 3.0% and 2.8% increases the prior two months, mostly driven by higher prices for agricultural exports. Compared to a year ago export prices are 18.8% higher, also a new high.
- Retail sales rose 0.5% in the month of March, near expectations, while February’s 0.3% increase was revised up to a 0.8% increase. Excluding vehicle sales, which have slowed lately, sales were 1.1% higher, above expectations. We know gas prices are high and that has a big impact on the headline number, if we look at sales excluding vehicles and gas, the gain was 0.2%, higher than the -0.1% expected. However, inflation was 1.2% in March so real retail sales (inflation adjusted) fell 0.7%. Retail sales are 6.9% higher from a year ago, but down 1.6% adjusted for inflation. Nominal gains were seen in merchandise stores (+5.4%), electronics and appliances (+3.3%), sporting goods/hobby stores (+3.3%), and clothing (+2.6%) while the weakness was in e-commerce (-6.4%), and vehicles and parts (-1.9%).
- Delta Airlines was the first airline to report first quarter results and beat expectations while increasing its guidance for 2022, saying its capacity will be 84% and revenue will be at 93% to 97% of 2019 levels, the previous peak in airline travel. The company made upbeat comments on demand, saying consumer demand accelerated through the first three months of the year with the month of March returning to profitability, driven by “strong performance in the spring break period” and the continued reopening of the economy.
- After purchasing over 10% of the stock, the world’s most wealthy person, Elon Musk, made a $54.20 per share cash offer to buy Twitter last week. Musk said the company has “potential to be the platform for free speech around the globe” and Twitter will not “thrive… in its current form.” Then, on Friday, the board announced it was adopting a shareholder rights plan, or a “poison pill,” to prevent a takeover by Musk.
- Several big banks reported quarterly results last week and the story line was lower revenues from investment banking due to less dealmaking, lower equity and fixed income trading revenue from a post-pandemic decline in trading, markdowns from Russia, and setting aside millions in reserves for potentially bad loans. Those negatives far outweighed solid loan growth and expanding net interest margins due to higher rates. JPMorgan CEO Jamie Dimon also said they remain optimistic over the short-term but see “significant challenges” ahead.
- For the first time, President Biden called the Russia’s offensive in Ukraine as a genocide due to the mounting evidence. Meanwhile, the Pentagon met with some of the largest U.S. defense contractors to calculate the capacity to meet Ukraine’s need of weapons if the war drags on years. Later in the week the White House announced $800 million in additional military aid to Ukraine, bringing the total aid to approximately $1.7 billion. Regarding the economic consequence of the war, the World Bank says it expects the Ukraine economy will shrink by 45% this year. Around mid-week, one of Russia’s flagship warships was struck by a Ukrainian missile and sank in the Black Sea, something Russia claimed was due to a fire.
- Crude oil rose from $75/barrel at the beginning of the year to a high of $130.50 in March as demand continued to improve and supply remained constrained, worsened by Russia’s war in Ukraine. Since then crude has trended around $100/barrel. As a result of the war, European nations have discussed the possibility of sanctions on Russia and banning import of energy from one of the world’s largest producers. In a meeting between OPEC and the European Union, where the EU called on OPEC to raise production to replace Russia’s supply, OPEC said it would be impossible to replace that volume, indicating it would not pump more. The group also said it would create one of the worst oil supply shocks ever, resulting in another increase in oil prices.
- The interest rate on the most widely used 30-year mortgage loan rose above 5% for the first time in over 10 years, according to the Freddie Mac mortgage market survey. The rate rose from 4.72% the prior week, is up from 4.16% since the Fed’s March 15 meeting, and up from 3.11% when the year started. The higher rates have resulted in a large drop in refinances but have yet to cool the housing market. That is expected to change eventually, and we could see if that affected March housing sales this week with several housing reports. Realtor.com said the increase in rates and home prices makes the payment on new mortgages 38% higher compared to a year ago.
Did You Know…?
Dividends & Stock Buybacks:
Just two years after the start of the Covid pandemic, companies are returning capital back to shareholders at a record pace via cash dividend and stock buybacks. Companies are sitting on about $2 trillion in cash and look at these two methods to return some of that cash to shareholders. A stock buyback reduces the amount of shares outstanding, artificially raising the earnings per share and making each share more valuable. According to S&P Dow Jones Indices, fourth quarter 2021 share buybacks for S&P 500 companies amounted to $270.1 billion, a 15.1% sequential increase and more than doubling from a year earlier. The information technology and financial sectors made up most of the S&P 500’s share buybacks. Dividends paid in the fourth quarter was $133.9 billion, a 3% sequential increase and 10.1% higher from a year ago. Information technology and health care were the two sectors paying the most in dividends.
The Week Ahead
The economic calendar is a little lighter this week, but the earnings calendar picks up. On the economic calendar the focus will shift to housing with a housing market survey from the National Association of Home Builders housing market survey, as well as new housing starts and permits, and existing home sales. Economists expect a slight drop in housing permits to 1.830 million and existing home sales to 5.860 million. Elsewhere we will see weekly jobless claims and the Philly Fed survey index on Thursday. Roughly 70 S&P 500 companies will be reporting first quarter results this week with a chunk of blue chip companies, including seven Dow components. Notable reports will come from Bank of America and JB Hunt Transport on Monday, followed by Netflix, Hasbro, Johnson & Johnson, Lockheed Martin, and IBM on Tuesday, Proctor & Gamble, Abbott Labs, Tesla, Anthem, United Airlines, and Lam Research on Wednesday, AT&T, Dow, American Airlines, Philip Morris, and Snap on Thursday, and Verizon, American Express, and Kimberly-Clark on Friday.