A solid report from Nvidia# attempted to reverse a February 5% pullback in major averages led by the Nasdaq gaining 1.5% in early morning action yesterday. Artificial intelligence (AI) continues to dominate the bullish side of market moving headlines. Nvidia is obviously a major player for computing power and has a tremendous lead on their competitors. They mentioned AI 75 times during their earnings call. For comparison, Microsoft mentioned AI only 31 times. Bitcoin’s rapid recovery from $16k to $25k helped demand for their chips as well. Whatever they are doing, it is working as the stock jumped 14% yesterday. That puts the stock at 70X forward earnings and up 60% already this year.
As noted over the past few weeks, some hints of froth are coming back. When a cash-burning Carvana doubles in 2 months and Spotify, Tesla, Roku, Peloton or even online gambling site DraftKings jump more than 50%, one can be sure risk mode is back. This is typical after major selloffs, but also a major concern for Fed officials who are trying to quell inflation, slow the economy and negatively impact labor markets.
Stocks were unable to hold on to all of their opening spikes as equity investors are booking early year profits but are also (finally) coming to the realization that the Fed is not just talking tough. While some Fed officials tout a possible jump back to 50bps increases as the labor market keeps holding steady, more likely is that we get at least 2 more 25bps and zero rate cuts in 2023 unless a hard landing occurs. Today, we get the Fed’s preferred inflation measure, the PCE inflation data, a consumer sentiment report, new home sales along with 5 different Fed members speaking. The sum of which could push 50bps odds in March higher. In either outcome, buying stocks at 18x forward earnings is a difficult proposition when an inverted yield curve, manufacturing leading indicators and massive tech layoffs are pointing towards at least a minor recession. Selectivity remains key as this rolling recession takes shape and offers upside in select areas.
Retail Earnings Reports:
US consumers remain the primary driver of GDP and therefore corporate revenues and profits. A very mixed week of retail earnings updates and projections does not make the future any less cloudy than before. Behind Amazon, which garners a lot of their sales from third party sellers, apparel and more discretionary purchases, Walmart# is the most important indicator for spending, especially middle to low-income earners. A lot of what they said was expected: consumers are tightening their belts due to increased spending on food and life’s necessities. Anyone who has bought eggs, bacon, chicken wings or butter over the past few weeks (and enjoyed that menu!) understands the outrageous prices we are now paying relative to history.
Management from Walmart phrased the consumer as being choiceful, discerning and thoughtful. They also note a noticeable shift toward private label brands, which screams caution. On top of that, half of their market share gains are due to higher-end consumers. Lower income consumers have been living paycheck to paycheck for decades. A rise in the price for life’s necessities directly impacts discretionary spending. That is now expanding up the food chain with many shoppers starting to penny-pinch and move down the quality scale in order to save a buck. Again, this is all good news for Walmart, but not so for the broader economy.
Home Depot#, Dollar General, Papa John’s, eBay, and Domino’s Pizza also reported earnings with similar question marks but a more negative reaction with stock drops of 4% – 12% following their update. Those stocks suffered more than Walmart as they do not benefit at all from a slowdown in spending than a company who gets over 50% of their revenues from groceries with rising prices. Though consumers are in solid shape due to wage increases, stuffed but dwindling savings accounts and still elevated home values, there remains a question as to what happens when those excess savings are finally spent. Inflation rates are handily ahead of wages gains. Consumer incomes are not keeping up with their cost of living. Throw in much higher interest rates impacting loans, mortgage refi’s and credit card balances one should be cautious with respect to any frothiness coming back into stocks. One of the more astonishing numbers comes from Home Depot. 90% of their customers have fixed mortgages with rates below 5%. Who is going to attempt to refinance, take equity out of their home when interest rates are at 6% – 8%? Home values are also unlikely to appreciate much over the coming years after seeing 25% – 50% increases during Covid, crimping upside for “free money” spending as opposed to the previous decade. In fact, home values are already down 6% – 8% in California, Arizona, Nevada and Washington. Only 5 states have avoided declines thus far. Is this all priced in?
Employment – Lagging Indicator:
Historically, employment has been the last economic indicator to fall. Companies see a slowdown coming but focus on other cost-cutting areas before laying employees off. Capital expenditures, operational expansion, travel and entertainment cuts are all low hanging fruit to help stem margin declines when revenues start to slow/drop. We would tend to see average work week and wages cut before actually laying off workers. Firing employees is expensive, disruptive and a last-ditch measure to protect profits. Hiring, then training new employees can be very expensive. There has yet to be anything near a drop in wages or hours worked. What has occurred though is a near record spike in credit card debt which rose by $61 billion last quarter. The worst part is that average credit card interest rates today are approaching 25%. People do not have enough money to order from Domino’s anymore.
However, unemployment hardly ever increases until a recession has already begun. The last 11 recessions saw the unemployment rate bottom within months of the recession. The start of each recession was within 0.5% of the cycle low for unemployment and each one saw unemployment rise by 1% – 3% within just 12 months. Buyer beware when one hears the phrase “everyone is working, everything is fine.” Here is the data from Real Investment Advice going back to 1950, with the caveat that maybe this time is different. The grey bars on the chart below represents recession.
Selectivity remains key as this rolling recession is causing historic norms to be a terrible roadmap. There are not many times when travel and leisure spending skyrockets but digital ad spending collapses. Semiconductor earnings do not normally drop by 50% while industrial profits spike higher. Banks do not see net interest margins and commercial loans rise when the housing sector sees demand come to a halt. We may be past the pandemic, but its side effects remain. 1-year T-Bills yielding 5% are a real alternative!
Floyd Mayweather, Jr turns 46 today. Nike Co-Founder, Phil Knight, is now 85. Actress, Debra Jo Rupp from That 70’s Show, turns 72.
James Vogt, 610-260-2214