Won't anyone go shopping with me?
Consumers may hold the key to whether it's a recession or "softish" landing.
Are you seeing any sales at the mall yet? Store shelves are filling up fast. Big earnings misses at Target and Walmart drove this week’s steep sell-off, with retail suffering its seventh-worst session of all time on Wednesday. As Bank of America put it, the most-consensus trade of the year, the low-income consumer, is finally playing out, if more quickly than most traders could catch it. Facing sticker shock everywhere they look and forced to spend more on groceries and gas, shoppers are resisting price increases for non-essentials. They’re trading down, substituting cheaper private-label brands for name brands, avoiding a lot of big-ticket goods and skimping on extras. The rapidity of this shift in the consumption mix caught retailers off guard, Target’s CEO said. Even though customer traffic was up in April and May, the discounter is having to eat higher product, labor and transportation costs to maintain or lower prices enough to attract business. Good news for inflation and consumers. Also, online sales and stay-at-home goods and services are slowing as Americans re-engage with the world. All this has forward profit margins for retailers falling from around 7% at the start of the year to an estimated 5%. That was quick! And, Consumer Discretionary has been the biggest year-to-date (YTD) decliner among sectors.
What about consumers? They’re in a horrible mood—Michigan sentiment hit an 11-year low this month, with elevated inflation top of mind. Lower-end consumers in particular are feeling the pinch. It can cost more than $100 to fill up the car and $10 or more for a box of cereal. The stimulus checks are gone. They’re burning through savings—a personal savings rate that spiked to a record 33% two years ago is now at a 9-year low. Credit card borrowing is surging, and the share of delinquent subprime credit cards and personal loans rose an eighth straight month in March. JP Morgan calls it the “consumer deterioration story.’’ Although, spending as a whole appears to be holding up. April sales were very strong (more below). Weekly payment card transactions keep running 10% above pre-pandemic levels. Evercore ISI’s weekly proprietary shopping survey is near pre-pandemic highs, as are airline and restaurant reservations. American consumers spend money when they are happy. But when depressed, we spend even more! I’m off to the mall, wanna come with?
As for tech stocks, they’ve had a horrible 12 months and their impact on the market is vast. Representing a fifth of S&P 500 market cap, they’re still trading 20-40% above their long-term trends, raising odds for more downside. And Strategas Research shares that the combined relative performance of Consumer Staples, Utilities and Big Pharma stocks over the last three months falls in the 99th percentile of all observations over the last 40 years—rare outside of recessionary or pre-recessionary periods. A decline to S&P 3,800 (precariously close as we write) would represent key technical support and if it breaks below, an acceleration to 3,500 would line up with the prior February ’20 highs, constituting a 50% retracement of the March ’20-Octber ’21 rally. While forward earnings estimates remain on an uptrend, the percentage of companies issuing negative Q2 EPS guidance has risen to 70%, above the 5-year average of 60%. But it’s really about re-valuation. Market sell-offs over the past decade ended only after the P/E multiple got close to 15x forward earnings. Though down nearly 6 percentage points YTD, it’s still above 16x. The current downdraft already represents the sixth-largest non-recession correction in post-World War II history. The Dow is on track for its eighth weekly loss, the first time since 1932. And yet, put/call ratios haven’t surged, and the VIX stubbornly remains below 40, even on big sell days. So, where’s the capitulation? Maybe we don’t need it? Goldman Sachs reports that since November ’20, we have seen $1.3 trillion in cumulative global equity inflows, more than the previous 20 years of inflows combined. So far this year, we’ve only seen about $40 billion in net outflows, or less than 3% of the ’20-’21 inflow number. Further outflows would represent a major headwind to the index. Chew on that for a while.
- This doesn’t look like a budding recession April industrial production rose 6.4% year-over-year (y/y), more than triple consensus, amid gains all over. Manufacturing was up 0.8% month-over-month (m/m), the capex-sensitive business equipment category increased 1.1% m/m and the utilities component—an input into consumption in the GDP accounts—climbed 2.4% m/m. Capacity utilization had its highest reading since December 2018, bolstered by a 7.5% m/m increase in total motor vehicle assembly.
- Nor does this April retail sales jumped 8.2% y/y (real sales, which retailers don’t report, were slightly negative). A drop in gasoline prices weighed on sales but was partially offset by higher volumes, and sales were strong across other categories except building materials and sporting goods. Four months into the year, core retail sales have advanced at an 18.2% annual rate, about twice the pace of CPI.
- Housing tailwinds Housing market conditions remain tight as a drum, with the Q1 homeowner vacancy rate of 0.8% its lowest since at least 1956 and the rental vacancy rate of 5.8% its lowest since the mid-1980s. These low vacancies represent strong underlying conditions that have builders struggling to keep up with demand. While April housing starts and permits declined, they remained elevated, with both authorized but not started projects and homes under construction advancing on the month.
- Housing headwinds Existing-home sales fell a third straight month in April to their weakest pace in nearly two years, as the same factors undergirding builders keep pushing prices to new highs. Combined with mortgage rates that have jumped 250 basis points in just a few months, affordability has worsened significantly. However, at this moment, the National Association of Realtor’s Housing Affordability Index is still broadly in line with its long-term average as mortgage rates were very, very low.
- Not yet the wage-price spiral of the ’70s Higher wages may be a contributor but larger factors arguably are driving inflation. In fact, annualized CPI since March ’21 has persistently run above wage inflation, which has been trending at 5.5%—about 3 percentage points below the CPI rate. By comparison, wage inflation exceeded CPI from ’65 to ’74 and ’76 to ’79, creating a true wage-price spiral in those decades.
- Watching manufacturing weakness for recession signal Contrary to April’s bullish manufacturing reading (above), May’s New York and Philly Fed gauges came in well below expectations. The Empire index fell to its second-lowest level since May ’20, with widespread weakness among components. The Philly index also declined to a May ’20 low, although shipments and new orders grew.
A China “put?” It cut its policy rate for a second time this year and by a larger-than-expected amount. The move came as Covid cases are starting to slip and Shanghai is opening up after nearly two months of draconian Covid measures. Coastal provinces south of the city are home to lots of manufacturing hubs, especially goods for export that have been piling up. Full shelves equal bargains.
Something for the bulls Bank of America’s fund manager survey showed cash balances at their highest levels since 2001. While this doesn’t always translate into immediate buying opportunities, it does tend to happen near many prior intermediate-term lows. Thus, while markets can certainly still fall further, the risk/reward for being short arguably is growing poorer.
Dems looking for a lifeline After passage of their partisan $1.9 trillion stimulus bill a year ago, inflation started to increase noticeably. Ironically, this might help with midterms month as y/y comparables start to improve in coming months not because the inflation situation is getting any better but because future monthly CPI figures will be compared to higher bases of inflation from the prior year.