Stocks finished lower on Friday after an earnings disappointment from Amazon#. They finished lower for the week but managed to report modest gains for July.
Amazon actually had good results that were generally in line with or slightly better than expectations, but forward guidance for retail revenues was less than hoped for. Many tech stocks have been benefiting since the beginning of the pandemic as businesses accelerated conversion to the cloud while workers worked remotely. Amazon’s retail business clearly was helped by stay-at-home Covid-19 buying. Growth, going forward, will still be well in excess of overall corporate growth. With nominal GDP growth in the second quarter close to 13% and likely to fall in half within 12 months, it is more than logical that Amazon’s retail sales will rise at a much lower rate than we just saw in Q2. The good news for Amazon owners is that AWS, its cloud business, still has a full head of steam. As a result, the company will continue to grow at a very strong rate for years to come.
Despite, the good news and a less than rosy retail outlook, Amazon’s stock fell over 7% on Friday. It simply fell back to the mid-point of its recent range. Bottom line: business is fine, including the expected deceleration, but valuation is stretched near term and the odds of a near term upside surprise are less than 50-50.
Contrast Amazon with Procter & Gamble#. It reported a good June quarter but forecasted that growth would be cut in half over the next year. That isn’t all that different than Amazon’s retail outlook in that growth will fall 50%. P&G clearly benefited in the pandemic in some ways, such as a boost in products, like paper towels. But items like soap, toothpaste and diapers are used pandemic or no pandemic. Some businesses (e.g., shaving) were probably hurt by working from home. However, while PG’s multiple was high given the low interest rate environment, its stock will be less impacted by decelerating growth than the Amazons of this world. In a maturing bull market, historically P&G has been viewed as Mr. Dependable, lower risk, well managed, and paying a decent dividend. Investors rewarded its tepid outlook on Friday with a gain of over 1%.
We have all known for a long time that Q2 growth is unsustainable. Obviously, year-over-year comparisons are greatest now because the spring of 2020 was a period of maximum economic shutdown. Even on a sequential basis, growth is destined to slow, and perhaps a little faster than some may have felt a few months ago.
1. The Delta variant wasn’t anticipated months ago. Clearly, it is more contagious and presents additional national health issues. The economic impact is undefined. It almost certainly won’t cause more quarantines. So far, the biggest impact, according to government mandate, is the wearing of masks once again. It is unlikely that the Delta variant will slow growth meaningfully. How much is still uncertain, but it certainly won’t accelerate growth. Thus, its economic impact is a modest negative, the scope of which still has to be flushed out.
2. It’s clear supply chain disruptions are having impact. Many companies are predicating more moderate forward-looking guidance on the impact of supply chain disruptions. That is particularly true where the shortage of semiconductor chips affects both production and sales. That ranges from autos to smartphones. We have seen the results of supply chain disruptions for months. The durability of the impact, in some cases well into next year, is a bit of an unpleasant surprise.
3. If you haven’t noticed, despite the fact that the current unemployment rate is a bit higher than pre-pandemic levels, finding qualified workers is difficult. That ranges from entry level workers at McDonald’s# to sophisticated software programmers. The obvious result is wage pressure, and that isn’t going away. Company after company notes in their forward guidance that persistent cost pressures are going to be tough to offset in the second half of this year. Those with pricing power are likely to raise prices. So much for transient inflation.
4. There is a housing shortage brought about by anemic new home construction since the Great Recession and demographic changes that accelerate demand from millennials wanting to move to the suburbs to empty nesters eager to downsize. The housing shortage has elevated home prices and is beginning to accelerate rents. Rents are the most important component of CPI. The combination of rising rents and rising wages suggests strongly that inflationary pressures may not be transitory. In the short run, a reversal of the run up in consumer prices could be offset by some correction in commodity prices. In the long run, offsetting both accelerating wages and rising rents will be difficult.
Thus, we still expect economic bumpy times ahead. Bumpy means volatile, not down. As we have said often, transition creates bumps in the road, but doesn’t necessarily mean directional change. The keys remain changes, if any, in the overall earnings outlook, and changes, if any, in the inflation outlook. Changes in the earnings outlook, if one only looks at the news last week from Amazon and Procter & Gamble, is modestly downward, meaning earnings will still grow, but at a slower pace. So far, it appears that changes in interest rates also remain downward although it is unclear whether that is a function of Fed bond buying or a change in inflation expectations. As both evolve, the market will react. It won’t be a one way street. Thus, we predict the highlight of the next few months may be more volatility than a dramatic change in direction, up or down. With all that said, the Fed continues to buy $120 billion in bonds every month leaving the backstop to financial asset values in place at least through the rest of 2021.
Today, actress Mary-Louise Parker is 57.
James M. Meyer, CFA 610-260-2220