Week ended May 20th 2022
U.S. retailers further undermine U.S. equities
“To be clear, this selloff is NOT about rising fears of inflation, but about rising fears of the consequences if inflation is brought under control. Doing that could hurt.” – John Authers, Bloomberg Opinion, May 19, 2022
It was another highly volatile week, with severe weakness resonating from missed bottom-line earnings from Walmart and Target (+other US retailers) caused by higher-than-expected operating costs. Negative variances on the cost side were driven by a combination of inflation-related issues (mainly higher wages/too many workers), higher energy costs and supply-chain disruptions.
The bright spot for global equities was mainly in Asia, with equities in China performing well (SSE Comp +2.0% WoW). The star performer of the week though was the emerging markets index – the MSCI EM – which was up 3.1% WoW, no doubt helped by a weaker US Dollar that finally seemed to encounter some resistance near the $1.05/basket level (USD -1.5% WoW). The S&P 500 was the worst performer of the week, with European bourses also negative although less so.
US equities continued to weaken albeit in an orderly manner. Volatility in the market remains elevated (VIX week close 29.43) albeit there is no real feeling of panic. This is especially hard to imagine when you have days like Wednesday when the S&P 500 was down 4.0% on a single day. As has been the case most of the year, the NASDAQ shouldered most of the pain, down 3.8% WoW, but there was no place to hide as far as US stocks. All of the US indices I track were down as negative sentiment broadened because of the poor earnings of retailers (see section below). Only a last-hour rally on Friday, attributable at least partially to the monthly expiration of options (circa $1.9 trillion), made a horrible week slightly less bad.
The US Treasury bond market has become the repository of the equity collapse Stateside, re-establishing the normal correlation of “equities down/bonds up” as investors have sought safety. The flow into USTs as a safe-haven has overwhelmed inflationary concerns, as investors seem to have concluded that the curve represents fair value. The short-end in particular is an accurate reflection of the likely path of increases in the Fed Funds rate in the coming months, with the yield on the 2y UST steady this week. However, intermediate and long-maturity USTs rallied with the yield on the 10y UST declining 15bps WoW (Friday close 2.78%).
Corporate bonds (credit) continued to suffer, too, as both yields and spreads moved wider on the week. As with the weeks before, high yield had more significant spread widening that investment grade, which is not unusual given the context. Within high yield, the weaker the ratings category, the more significant the spread widening. Although default data does not yet indicate this, the behaviour of credit spreads is in my opinion indicative of credit investors becoming increasingly confident that the combination of higher yields and a slowing economy will not be favourable for more leveraged companies.
Oil steadied this week, actually closing up 2.0% WoW, whilst gold also found a bid amidst the general risk-off attitude of investors. The US Dollar finally weakened, steadying the British Pound and Euro as – at last – the ECB appears to be becoming increasingly hawkish. Cryptocurrencies remain under severe pressure as the alternative asset class is experiencing a shake-out, although the benchmark BTC was only marginally down WoW (Friday end of day $29,201).
Major events driving markets last week
UK inflation: UK inflation came in red-hot as it heads towards double-digits, and the outlook for the UK economy worsened. CPI rose 2.5% from March (MoM), and was 9.0% for April (vs April 2021), according to data released mid-week by the ONS (here). Rising inflation was not unexpected, and Governor of the Bank of England Andrew Bailey said as much in a grilling before the House of Commons Treasury Committee on Monday. Naturally, he was accused as being at the helm of the central bank that mis-called the persistence of rising inflation. Does that sound familiar to readers that focus mostly on the Fed and its under-pressure chair Jerome Powell? It certainly should. Mr Bailey laid the blame for out-of-control inflation at the feet of things that could not be foreseen, including the invasion of Ukraine by Russia and the prolonged COVID crisis. Chairman of the Exchequer Rishi Sunak is also feeling intense heat, as Brits face sharply higher cost-of-living expenses and deteriorating personal finances. There was plenty written about UK inflation and collateral effects in the mainstream press early in the week, but in summary, the BoE and UK government seem to be between a rock and a hard place. There is little doubt the BoE will continue to raise the overnight borrowing rate to deal with the country’s worst inflation since 1982, and this is highly likely – as the BoE has predicted – to lead to a recession starting in the 4Q22. The damage of this steady march towards genuine stagflation in the UK will undoubtedly also continue to heap pressure on the Pound, which is down 7.7% YtD (vs the USD).
US retailer earnings: The bottom-line misses by both Walmart and Target on consecutive days early in the week snuffed out the nice recovery in US equities that occurred on Tuesday, sending the indices to the sharpest single-day declines on Wednesday in months. On the surface, you might be thinking that these are not the type of retailers that would suffer from a gradually slowing US economy as things normalise post-pandemic (hopefully). However, both companies suffered from escalating costs that they could not fully pass through, including transportation costs, wage costs (inflation + too many workers) and supply-chain disruptions. These factors caused an unexpected increase in operating costs, pushing down profits even as both companies had decent top-line and same-stores sale growth. Both companies also guided analysts lower as far as FY earnings. Perhaps Amazon’s poor quarter should have served as a harbinger. Other retailers, including some well-known apparel and retail giants (e.g. LULU, NKE) were splattered by missed bottom lines and revised guidance of WMT and TGT. Ross Stores (ROST) and Kohl’s (KSS) also missed analysts’ expectations and revised their 2022 guidance downwards, with shareholder paying the price. The retail ETF index XRT was down 9.5% for the week, whilst WMT (-19.5%), TGT (-29.0%), ROST (-21.9%) and KSS (-19.7%) were all sharply lower.
Other: To add fuel to the fire, we have the ongoing trifecta of COVID-related shutdowns in China, the Ukraine-Russia war, and increasingly hawkish monetary policy. I can look at China in two different ways. On one hand, the country’s economic growth this year will fall massively short of government targets, a big issue in China. On the other hand (for equity investors), the COVID-closures and economic slowdown will almost certainly be countered through some combination of monetary and fiscal stimulus. This will take time to work through the economy. Until then, the main outcome will be not only ongoing supply-chain disruptions due to COVID shutdowns, but also tepid consumer demand in China which will almost certainly translate into lower global growth.
Economic data to be released this coming week includes: US housing data (new May 24, existing May 26), release of FOMC minutes (May 25), Japanese first-read CPI for May (May 26), and revisions to 1Q2022 GDP in the US and Germany (May 25/26), US sentiment (May 27). Otherwise, we are “data-lite+ heading into the end of the month. Next Monday (May 30) is a holiday in the US FYI, with both equity and bond markets closed. I suspect that volumes in US equities and bonds will fade as we near the end of week.
I continue to be in the camp that inflation can and will be addressed in the world’s major economies, but it will come at a painful cost to growth. The US arguably has the most room to manoeuvre, but even then the Fed will need to thread a needle to get its hawkish shift precise. What is increasingly clear is that the Fed seems focused on removing excesses from risk asset classes, so the often-discussed “Fed put” is coming into question, very much the intention of the central bank. Eventually this will spill into real estate, which is cooling but slowly Stateside. And this will then risk having adverse wealth effects on consumer spending. You should be able to envision the cycle, very tricky to say the least.
Global equity indices
US equity indices
US Treasuries (yields)
Corporate bond yields
Corporate bond spreads
Safe have and other assets