“We see our customers showing ongoing discretion and making trade-offs to be able to afford the things they want, given the sustained high cost of the things they need…” John Rainey, EVP and CFO, Walmart (during management call following release of 3Q23 earnings)
"The slowdown in luxury demand globally is having an impact on current trading. If the weaker demand continues, we are unlikely to achieve our previously stated revenue guidance for FY24" ,Burberry said in its earnings report
Although global equities were on fire this week, I must start this update by saying that I am struggling to fully grasp the rationale. Investor optimism over lower yields and growing confidence that the Fed and other central banks might bring forward their so-called “pivot” towards more dovish monetary policy is fuelling the rally. Disinflation has become the norm now in most economies although there is a ways to go before the coveted 2%/annum inflation target becomes a reality. I keep asking myself though: as price increases moderate due to a slowdown in end demand, it this really good news for corporate earnings in the quarters ahead?
For example, earnings reports from retailers were mixed last week, but most companies have been cautious regarding the outlook, especially over the all-important Christmas period.
Walmart (WMT) reported better-than-expected same store sales growth and marginally beat both top-line and bottom-line consensus expectations for 3Q23. Even so, the stock got hammered (down 6.5% WoW) because management painted a gloomy picture of the consumer in the months to come.
Not only are lower-end box retailers seeing consumers shift from discretionary goods to essentials, high end luxury brands like Burberry (LON: BRBY) are also seeing demand from their relatively wealthy target base fade. The stock was down 6.7% WoW.
Pressure on consumers at all income levels is visible now, even though aggregate retail sales data in the US has been mixed to favourable. Things are less bright on the other side of the pond though. UK retail sales for October, announced on Friday, declined 0.3% MoM versus expectations of 0.3% growth (ONS report here). The news regarding the UK economy keeps getting worse even as the Bank of England persists in its fight against inflation, the highest among G7 countries. October retail sales in the Eurozone, announced week before last, also declined 0.3% (Eurostat report here). There is little doubt that the impact of inflation and higher interest rates is starting to bite consumers, and this can’t be positive for most stocks in the coming quarters even though “higher for longer” is the cost of reining in inflation
Weaker-than-expected CPI fuels rally
Tuesday was the biggest daily gain (+1.9%) in the S&P 500 since April 28th, adding to what has been a very strong month for the S&P 500 (+7.6% since the beginning of November). The driver on Tuesday was an ever-so-slightly below-expectations release of October CPI before the New York open (BLS CPI report here). As you can see in the graph below, YoY inflation (both headline and core) in the US is trending in the right direction.
This disinflation data caused US Treasuries to gap up in price (down in yield), and equity investors embraced this as a sign that the Fed’s “higher for longer” just might not be as long as originally thought. The rest of the week brought mixed economic data, including PPI and retail sales, sending a message that we remain far from out-of-the-woods as far an inflation. US Treasury yields bounced around during the week but were lower across the curve as bonds continued their November rally, too.
Lower yields are particularly good news for companies that rely on the debt markets for financing, in that their cost of financing could begin to decline sooner rather than later. The best proxy for this is the small- and mid-cap laden Russell 2000, since these companies are more likely to use debt as a key component of the capital structure. And indeed, it was the Russell 2000 – the value index that has kept investors waiting and waiting for some sign of life – that took off like a rocket on Tuesday, up 5.4% on the day as yields declined post-CPI release.
Earnings started the rally
Before yields started to fall, the current rally in stocks – which started in late October – was ignited by better-than-expected earnings from S&P 500 companies for the 3Q23. However, the combination of more cautious management outlooks generally, and more and more data suggesting that US consumers might have depleted their pandemic savings, is not necessarily good news for stocks even though yields are falling. For now, investors seem to be saying “bad news is good news”, because a slowing economy might force the Fed pivot to more normal (or even dovish) monetary policy sooner.
US budget: “can kicked down the road” (again)
Fortunately one thing that was taken off the table this week was another budget showdown in Congress. On Wednesday, Congress approved its second interim 2023-24 budget extension, this one in two parts. One part expires on Jan 19th and the second part expires on Feb 2nd. You can find details of the so-called “continuing resolution” on the “Committee for aResponsible Fiscal Budget” website here. Since this is an interim solution, this will unfortunately stay on the list of concerns until Congress can get its act sufficiently together to pass something more permanent. Can’t the Republicans and Democrats agree on anything?
UK and Eurozone: retail sales and inflation decline
With weak October retail sales, it was not surprising to see the UK experience better-than-expected (meaning lower) CPI in October, raising expectations that we might have seen the last of Bank of England interest rate (ONS CPI report here).
Headline CPI YoY fell to 4.6% (down from 6.7% in September), and was flat MoM
Core CPI YoY was 5.7% in October, down from 6.1% YoY in September
EC Commissioner Paulo Gentiloni presented the Autumn Forecast for the EU, including the Eurozone, on Thursday. The remarks, which you can read on the EC website, sounded familiar. The growth forecast for the EU for 2024 is slightly better than I was expecting for 2024 (+0.6%), avoiding a recession, but still anemmic. The EC is forecasting slightly better growth for the EU in 2025 and 2026.
Central banks: now what?
I suspect that the ECB and BoE have probably reached an endpoint as far as rate increases, and it looks increasingly like the Fed might be at the end of its rate rises, too. The question in all three cases is “how long will tight monetary policy persist before there is a pivot?” Inflation remains stubbornly high in all three economies, but I suspect if economic growth slows sharply and / or the jobs market weakens quickly, any of all of these central banks might blink. At the top of the list would be the ECB (because inflation is falling quickly in the currency bloc), followed by the BoE (which is in the most precarious position suffering a clear bout of stagflation) and then the Fed. Of course, Japan remains the outlier of developed market central banks, but with the Yen now hovering around ¥150/US$1.00, I suspect the Bank of Japan might be forced to shift away from its extremely dovish stance sooner rather than later. As an aside, Japanese CPI for October will be released next week.
Other musings
The coming week is holiday-shortened in the US, with equity and bond markets closed for Thanksgiving on Thursday. The following day (“Black Friday”) has shorter trading hours, with US equity markets closing at 1pm and US bond markets closing at 2pm.
As far as my portfolio activity this week, I just enjoyed the run as an “always long” stock investor. However, there are a few names that have had sharp price appreciation in a short period of time that I am watching carefully, more in the context of writing covered calls than outright disposals. Alongside this, I am experiencing “investor’s remorse” caused by my views for a couple of months that UST yields would decline – which they have (so far) – but not having the conviction to extend the maturity of my own UST holdings beyond one year. Hindsight is a beautiful thing but can torment you!
MARKETS THIS WEEK
It was one-way traffic this week, with all of the equity indices EMC tracks gaining sharply on the week. Stateside, the Russell 2000 led the charge (+5.4% WoW) as small-caps suddenly became fashionable, although US stocks rallied broadly across the board.
Internationally, every equity index tracked by EMC was better this past week, although China was the poorest performer, up a mere 0.5%. Even though it has a heavy Chinese component, the MSCI emerging markets index performed well too (up 3.0%), thanks to a combination of a slightly weaker US Dollar and widespread risk-on sentiment.
US Treasuries also rallied hard this week, with yields down sharply at both the policy-influenced short end of the curve, and at the more economic-driven long end of the curve. The yield on the 10y UST declined 17bps, ending the week at 4.44%. The rally in Treasuries has generated attractive returns for both the 7-10 year and the 20+ year total return indices, which are up 3.5% and 7.9%, respectively, in November (compared to the S&P 500 which is up 7.6% in November).
The price of oil has continued to slide, another potential signal that the global economy might be weakening. This could change quickly though since the Israeli-Hamas war remains tenuous and could still prove to be a major potential flashpoint as far as oil supply disruptions.
The price of gold was higher WoW, while Bitcoin was slightly lower, although keep in mind that the price of BTC has more than doubled so far this year.
Corporate credit was flat to slightly better across investment grade and high yield, as credit markets remain constructive and open for business. Inflows have been sharply positive into high yield funds this month, suggesting that credit investors have few concerns about the economy at this point.
You can find detailed information on the indices and asset prices that EMC tracks in the section “The Tables” below.
WHAT MATTERS IN THE WEEK AHEAD
Things to watch:
Economic data: Preliminary services and manufacturing PMI for November will be released for the US, UK and Germany, given us a good flavour of how economic activity is holding up in these three important economies. We also get Japanese CPI for October on Thursday, and consumer confidence indicators in the UK and the Eurozone during the week.
Uncertainty in the Middle East: Direction of and contagion associated with the Israeli-Hamas conflict is ongoing and uncertain, heading in the wrong direction and increasing concerns that the conflict could broaden.
US 2023-24 budget: Congress approved a second extension of the 2023-24 budget until early next year, thereby avoiding another risk of a government shutdown. The two-pronged extension expires partially on Jan 19th and partially on Feb 2nd. This agreement kicks the can down the road (again), but at least we will to the end of the year without further Congressional drama related to the budget.
One earnings report that REALLY matters: Leading chip designer NIVDIA Corp (NVDA) will report earnings after the bell on Tuesday, as the last of the “Mag 7” to report this cycle. Consensus expectations are for $3.18/sh and top-line revenues of $16.12 bln, although earningswhispers.com is projecting a significant bottom-line beat. The shares are up 237% YtD, and trade at a forward P/E of 31x.
Upcoming central bank meetings:
Federal Reserve (FOMC): Dec 12-13
Bank of England: Dec 14
ECB: Dec 14
Bank of Japan: Dec 18-19
THE TABLES
The tables below provide detail across various global and US equity indices, the US Treasury market, corporate bonds and various other asset classes.
Global equities
US equities
US Treasuries
Corporate bonds (credit)
Safe haven and other assets
_________________
**** Follow E-MorningCoffee on Twitter, and please like and comment on my posts right here on my blog. You need to be a subscriber, so please sign up. Thanks for your support. ****