Summary: Stocks spiked higher yesterday, shrugging off lackluster earnings updates from the likes of huge pandemic winners Nvidia and Snowflake. Retailer updates were impressive, showing the consumer is not done yet, especially the high-end and those ready to travel. Is this rally the start of something lasting?
For the first Friday in two months, major stock averages are pointing towards a positive weekly return. Off-calendar earnings updates from Dollar General, Macy’s, Alibaba, Dillard’s, Ulta Beauty and Nordstrom showed a more resilient consumer, offsetting some concerns provided by Target# and Walmart# last week. It is becoming clearer that the high-end consumer is still flush with discretionary cash and is shifting spending desires to service-related activities: weddings, concerts, vacations and getting out of the house. This takes away from hard goods like home improvement spending, TV’s, laptops, appliances and time spent streaming from the couch. It is also crystal clear that the low-end consumer is feeling the brunt of pain stemming from inflation. There is a trade down. Private label businesses are taking share again and more people are shopping at dollar stores in order to save a buck. Although a mixed bag, the U.S. consumer is far from dead.
The most beaten down sectors advanced the most yesterday with Consumer Discretionary stocks up 5% and Technology up 3%. Safety areas like Healthcare, Consumer Staples and Utilities barely advanced, while the S&P was up 2%. This rally from last Friday’s lows is already over 6%. While some of this stems from deeply oversold conditions, likely short covering and some positive corporate updates, this rally gained steam after the release of the latest Federal Reserve minutes. It is becoming clearer the Fed will have some patience after the next two 50bps moves. If inflation can show a real downturn and the labor market tightens, it is possible the Fed could be done sooner than expected. Already we’ve seen nearly 2 rate hikes get pulled from 2022. A true rosy scenario would envision inflation dropping quickly over the summer months, while wage gains slow and unemployment claims get back to ~100k/month instead of the unsustainable 400k we’ve been seeing. This economy simply cannot handle spiking interest rates.
Obviously, the question becomes whether this is just an oversold rally or the start of something more substantial. While this may not be the exact, final low for all major averages, there are plenty of world-class operators trading at a significant discount to their historical valuation ranges where nibbling makes some sense if one has already built-up excess cash and can focus on the long-term. For traders, a relief rally could be anything from 5% – 15%. More cautious investors can wait until we get the all-clear signal that Fed tightening, repaired supply chains, stabilizing bond yields and China re-opening will be enough to engineer a soft landing. That won’t be clear until late summer at the earliest.
Since many of us are preparing for the long weekend, let me cut back on the words and show some important charts/graphs that may help paint a brighter picture relative to the past five months:
First up is the equal weight S&P index relative to the market cap weighted S&P. While the S&P is down 15% for the year, the average stock is “only” down 10%. In simple terms, the average stock already bottomed, but the mega-cap leaders may have more room to fall:
Next, we take a look at mid-term election years. Typically, they are more volatile than most as regime changes (there is no clear path for Democrats to remain in charge of all 3 chambers) cause chaos and elected officials play to their base instead of the country. Not much politically gets done to help either side of the aisle (you can’t blame just one party). With that being said, this year’s drop falls in line with historic norms, but the recovery from there is quite impressive:
As noted on numerous occasions over the past few weeks, investors are more bearish than during almost any prior period. This means most have already sold stocks and moved to safety. The bulk of major selling action has already occurred. Looking at current cash levels, there is plenty of fuel waiting to re-enter the market which could help propel us over the coming months:
Lastly, one should not get more bearish after drops like this. Buying when it feels the worst usually is the correct move. Putting cash back to work following a dramatic drop like the one we just had is historically the right thing to do:
The next 2 critical data points that will help fuel, or halt, this rally come next Friday with an update on employment and wages. Remember, half of the Fed’s mandate relates to full employment. Layoffs and hiring freezes in the technology sector have been ramping up lately. With margins collapsing and inventories rising at a lot of retailers due to a changing consumer, there are sure to be cutbacks there as well. This will help quell wage growth over time. Then the all-important CPI report, which will hopefully show a further decline for inflation. That is due out June 10th. For now, we enjoy a long weekend. Markets are closed on Monday in honor of Memorial Day.
Johnny Depp has been in the news lately, and his eldest daughter Lily-Rose turns 23 today. Paul Bettany is now 51.
James Vogt, 610-260-2214