Yesterday’s retail sales report was also surprisingly weak. Sales were flat month over month as compared to an expectation of +0.4%, so this supports the notion that inflation can continue to soften. Of the 15 retail categories, more than half reported deceleration in sales growth. Finally, this morning’s initial unemployment claims and housing starts/building permits figures also came in slightly weaker than expected. These reports rhyme with what we are hearing from retailers themselves.
Walmart posted strong results this morning. Management noted that it is benefiting from more people eating at home which is less costly than eating out these days. In addition, Walmart said that it is attracting more high-income earners as consumers are “trading down” to save money. On the flip side, Home Depot reported its quarterly results on Tuesday. Unsurprisingly, it posted its 6th consecutive quarter of comparative same store sales declines. The stock price didn’t change much as investors understand the near-term headwinds. Higher interest rates, inflation, and economic worries are showing up in the form of weak sales growth, particularly for discretionary consumer goods. But if the “soft-landing” thesis plays out as expected, growth will resume after a period of interest rate adjustment.
Tame inflation and weak retail sales figures are fuel for the mini market melt-up we have seen these last two weeks. Powell’s comments have strengthened investor sentiment and reinforced the expectation that there are no future rate hikes ahead. The Fed is done hiking and it is only a matter of time before the cost of money once again gets cheaper. This change in investor sentiment is most powerfully seen in the decline of the US Treasury 10-year yield. After reaching a recent peak of 4.7% on April 25th, the 10-year yield has declined to 4.3%.
A decline in the 10-year US Treasury yield acts like a teeter-totter, or seesaw, (depending on where you are from) that we used to play on as kids. The laws of physics sometimes apply to economics and markets. This is one such case. As the yield goes down, the value of assets goes up. And, just like the end of the teeter-totter board that goes up the most, those assets with expected long-term streams of growing free cash flows (i.e. growth stocks) usually experience the biggest lift from declining long-term interest rates.
Squeezing the inflation rate down from 3.6% to the Fed’s 2% target may take a bit longer than Fed officials would like. The mixed inflation reports we have seen so far this year may be impacting consumers’ expectations. Gas prices and food inflation, even if not rising further, remain at levels that consumers gauge as “too high.” In fact, the NY Fed just reported survey results that confirm a rise in inflation expectations to 3.3%, which puts the Fed in a tough position.
Moreover, financial conditions can hardly be viewed as excessively restrictive with home prices near all-time highs and a stock market trading for 22x FY24 estimated earnings, as compared to a 25-year average of 16x. Thus, the last thing the Fed wants to do is re-ignite inflation which would force additional rate hikes. For this reason, it is difficult for us to forecast an aggressive Fed rate cut cycle ahead, much less a repeat of the roughly 10% year-to-date stock market gains as we progress through the second half of the year.
Nonetheless, it is a company’s ability to grow earnings that increases a stock’s value over the long term, not whether the Fed cuts rates this month or next. We continue to focus our efforts on finding those companies that are developing the right business models and relentlessly improving their value propositions to customers. Great companies overcome the ever changing economic and interest rate landscape.
We see lots of opportunities emerging in what could be a volatile market ahead, given today’s generally high valuation levels. Today’s winners may not be tomorrow’s leaders. Rapid changes in technology and powerful computing applications have the potential to re-arrange the future of many industries. So, as we dissect each and every economic report and Fed speaker’s comments, remember this is a marathon, not a sprint.
Actor Pierce Brosnan turns 71 today and actress Debra Winger and Olympic gymnast Olga Korbut both turn 69.
Christopher Gildea
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