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This week saw notable election results, geopolitical events, economic releases, and quarterly earnings reports from some blue-chip names. In the interest of keeping our readers’ sanities intact, I will focus this recap economic releases and quarterly reports…I think we can all use a break from the former.
We are entering an environment where investors have become acutely focused on nearly every economic release coming out of the U.S. (not just the marquee releases like non-farm payrolls, unemployment rate or GDP figures). Tuesday saw PPI figures that were slightly below expectations which initially caused strength in equity indices (slowdown in producer prices=slower economy, which could result in the Fed slowing the pace of rate hikes). Conversely, Wednesday’s retail sales figures came out better than expected (despite some substantial variances amongst certain retailers themselves – more details on this below). On Thursday St Louis Fed President Bullard (2022 FOMC voter) said that the Fed Funds Rate (the overnight lending rate between U.S. banks) is not high enough and indicated the Fed may need to go to 5-7% in the battle to get inflation under control (for those keeping score we’re currently at 3.75%-4% in Fed Funds).
We will likely continue to follow the bouncing ball on data releases until it becomes clear that inflation has not only peaked but is falling consistently. We think this will be a very bumpy road for the foreseeable future and expect to see strong variability in the economic releases and volatility in markets. The chart below shows the Consumer Price Index 12-Month Percentage Change since 2002 (the CPI is currently the most followed measure of inflation in the U.S.).
Economic Data – Bad News Continues to Be Good News
Source: Bureau of Economic Analysis, company Date, Goldman Sachs Global Research.
The latest CPI report of 7.7% was better than expected, but as my esteemed colleague Mr. DeSisto pointed out last week, it’s way too soon to break out the champagne – it’s going to be a bumpy ride, not an elevator trip to the ground floor.
To add more moving parts to the above, retail bellwethers Lowes (LOW), Home Depot (HD) and Walmart (WMT) had solid quarterly numbers while Target (TGT) warned on the 4th quarter and holiday season and was down as much as 16% intraday. This on a day when the Retail Sales Data overall showed strength, which is why TGT was punished so severely post their results.
Two Retail Realities
The variance of performance within the retail sector is an example of why stock selection is so important in this market. Walmart saw a boost in grocery sales in the 3rd Quarter, and Lowe’s stated that high inflation isn’t hurting sales (and promptly beat quarterly estimates and raised their full year guidance). Target, on the other hand, stated they see a weak 4th quarter and holiday season in general. Their quarterly results were hurt by continued inventory issues, and weakness in certain areas like apparel and electronics. In the current environment of inflationary pressures and continued supply-chain challenges, companies that show effective inventory management is paramount. Companies that can’t navigate their inventory efficiently will suffer in the short and medium term.
Overall, the trend in retail continues to be strong. The chart below (from Macrotrends.net) shows the Real Retail Sales (Inflation-Adjusted) retail and food service sales since 1992. The shaded areas show recessionary periods.
The Fed would like to see the above chart start to trend lower, without creating another “grey” column (a recession). This is a tall task, and many pundits are now forecasting a recession as their base case scenario.
We continue to be cautious on interest rate sensitive names (growth stocks, utilities, REITs) and favor dividend paying equities (not just high-dividend yield payers, but those who consistently GROW their dividend.) These types of companies have strong cash flow in any environment and will continue to provide protection vs their interest-rate sensitive counterparts.