Stocks were little changed yesterday. Positive momentum and lower interest rates were offset by weak earnings reports from Dow Components Cisco# and Wal-Mart.
Indeed, the Wal-Mart reaction puts an exclamation point on a fact all investors should know, that stocks react to how results compare to expectations, not to the actual results themselves. For most of 2023, Wal-Mart has been a pillar of strength seemingly immune to the shift of consumers from goods to experiences. It certainly helps that roughly half of its sales are groceries. Meanwhile, Target, a major competitor, was having all sorts of problems, mostly a mismatch of inventory to customer demand that led to several rounds of markdowns and reduced earnings estimates. Thus, when we entered this week and big retailers reported earnings, the expectation was more pain from Target and a solid steady Eddie performance from Wal-Mart. Target’s results weren’t great, but they weren’t disappointing once again as many feared. Its stock spiked creating a relief rally. Meanwhile Wal-Mart missed expectations by just a bit citing higher expenses. Moreover, it threw a wet blanket on Q4 expectations. Its stock tanked. If you simply looked at the results, you wouldn’t have expected either stock to do much based on the earnings news. But matching those same results to expectations explains why the stocks behaved as they did.
With that said I will change gears and talk about inflation. Every day, a new data item moves expectations and impacts interest rates. Nothing occurs in a straight line. The price of all financial assets imbeds consensus expectations. Thus, prices change day-to-day as expectations change. But long-term investors should try and step back, looking at the forest, not the individual trees. Look at the chart below.
You see the wild gyrations. But you also clearly see the trend if you just step back. It’s unmistakable. Moreover, it’s clear that monetary policy is moving the trendline ever closer to the Fed’s 2% target. More rate increases aren’t needed. Fed officials aren’t ready to say that publicly, but there isn’t one FOMC voting member expressing the thought that another increase in rates is needed now. Indeed, the futures markets place the odds of a rate increase at its next meeting in mid-December at less that 0.5%. The Fed will never absolutely say it’s done, but it’s done.
No wonder stocks are rallying and interest rates are falling. Look at the yield curve. This morning, one-year Treasuries yield 5.23%, almost exactly in line with the current Fed Funds rate of 5.25%. But the 2-year yield is down to 4.82% having been closer to 5.25% just within the last month. Clearly, markets are saying the war against inflation is ending, but the Fed will soon (within the year) be clearly on a path to lower rates.
Last month, 150,000 new jobs were created. If one factors in adjustments to prior numbers, the net increase was closer to 100,000 consistent with a soft landing and a slow growth economy. But we have been learning from retailers that there has been material weakening in the sales pace over the past several weeks. If that persists, it’s possible that the unemployment rate may continue to rise. It is even possible that net jobs in any given month could turn negative. The Fed officials speak with bravado about their intent to keep conditions tight until a stable pricing environment is certain. But 2024 is an election year. For the electorate, there is no more important economic set of indicators than the unemployment rate and the net change in jobs each month. While the Fed is an independent agency, if job growth turns negative, even if for only a month or two, the political pressure from incumbents to lower rates and start to stimulate will become intense.
One more point relative to inflation. Inflation measures changes in price. If prices stay at current levels, inflation is zero. But inflation doesn’t take into consideration the net change in prices over the last three years. Consumers, however, see that change every day. Your $15 dinner entrée is now $25. Your rent is also 25% higher. You only have so many dollars in your wallet. For the past couple of years, that has been helped by government largesse post the pandemic. But that extra money is running out. And more money has to go to interest costs or student loan repayments. Thus, while inflation is ebbing, it’s perfectly rational to see pressure on retail sales and consumer spending. Whether that means soft landing or recession is still in doubt.
The current rally is perfectly explainable. With the exception of large cap growth stocks which are overpriced on any historic basis, most other markets and market segments are close to historic valuation norms. But all assets aren’t priced identically. That means, in an equilibrium market, half the stocks are somewhat overpriced and half are underpriced. As we have seen over the past year or two, short-term shifts in both directions radically impacted performance for a short period of time. Major trends like rising infrastructure spending, the growing influence of AI, slower growth in China, and declining birth rates are key factors that will influence the futures for every company. Above all other factors, demographics are dominant. Technology cannot create more people. With that said, people move from place to place. Populations in countries like China, Russia and Japan are declining. Immigration is flowing toward the U.S., both legal and illegal. One can’t lose sight of the fact that population change is the single most important determinant of long-term growth. Productivity is next. Technology drives productivity while regulation and the cost of money are also key determinants. One conclusion, however, overrides all. The population growth rate on our planet is in decline. Policy can attempt to push growth beyond natural limits but if governments push too hard cracks appear including more inflation and rising debt service costs. You can’t fight Mother Nature.
Today, Danny DeVito is 79. Director Martin Scorsese turns 81.
James M. Meyer, CFA 610-260-2220