Just where are markets now versus where they are headed? Just where are the U.S. and global economies now versus where they are headed? It would appear, with 92% of the S&P 500 having already reported what on the whole, this has been a wildly successful third quarter earnings season. That corporate performance has been what has buoyed a broader market that remains close enough to all-time highs.
Last week produced for nearly every single domestic equity index that we follow, an ever so mild "down" week after five consecutive "up" weeks had carried both the S&P 500 (-0.3% last week) and the Nasdaq Composite (-0.7% last week) through the season. Over the past five days, the S&P 500 has been "reeled" in just a bit, now trading at 21.2 times 12 month's forward looking earnings versus the 21.4 times I reported one week ago.
While to this point, with for the most part, only the retail industry still standing unreported, (according to FactSet) S&P 500 companies have reported Q3 earnings growth of 39.1% year over year on revenue growth of 17.5%. This is versus expectations for earnings growth of 27.4% on revenue growth of 14.9% as the season began. Clearly, either corporate execution has been far better than even professional forecasters had in their wildest dreams anticipated, or businesses simply had an easier time passing on rising costs either to U.S. consumers or business customers. Regardless, what is clear, is that the margin compression that all of us had warned about for the third quarter was not the issue that we had made it out to be. Net profit margin across the S&P 500 for the third quarter with just a handful of names left to report, is running at 12.9%. That compares to the consensus view of just 10.9% as the season kicked off.
What we need to figure out as we proceed is to figure out if this margin compression that nearly all of us had seen coming, is just late, or simply not going to materialize to the degree that we had expected. Is this a fourth quarter issue? Right now, the same professionals expect to see S&P 500 earnings growth of 20.9% on revenue of 12.3%. Interestingly, as COVID has been probably the most determinant force in terms of how both fiscal and monetary policy have been exercised, as well as in how jobs have been both created and filled for more than a year and a half now.... the virus has also been the driver for almost all of the supply chain issues that we will hear more about over the next two weeks as the retailers report their quarterly digits.
The high-profile output generated by all those inputs coming to a head together has been the double whammy of increased producer and consumer prices. This is why you and I watched the University of Michigan's measure for consumer sentiment hit a 10 year low (66.8) for November's flash print, and this is why we all saw October CPI hit the tape at an "over the top" year over year print of 6.2%. Despite these awful numbers, it is easy to forget that the fourth quarter is off to a very decent start from a macroeconomic perspective. On that front, we look to this Tuesday's data for October Retail Sales, October Industrial Production and October results for both Import and Export prices. All of these factors are rolled into existing models that create real-time quarterly estimates, such as those published by the New York and Atlanta Feds that in turn, all of us cite in our work as we await "more official" estimates (which is all they really are) from the Bureau of Economic Analysis.
Key to Note
I think it key to note that we must keep heads clear in regard to the current bout with inflation, tough as it is to deal with. We have all seen the yield curve, and prices for precious metals, as well as equities directly relative to the materials sector react to these rising prices, not to mention cryptocurrencies. The fact remains that there are a number of factors that reach beyond the direct inputs of policy makers and the pandemic likely to be reflected in consumer level pricing moving forward.
While demographics, as well as technological progress and digitization have been nearly permanent deflationary forces on consumer prices in developed economies for a generation, the velocity of money has also slowed for more than a generation. Even with kinked up supply lines and labor markets, on top of amped up fiscal support, this velocity has not trended higher this year. Not in the least. Should there be no change in velocity, there can be no sustained change in inflationary trend. In other words, this inflation, as painful as it is, remains temporary in my opinion. I must stress that "this" inflation remains temporary. That does not mean, in my opinion, that domestic inflation soon returns to pre-COVID levels. We may have moved too far in a couple of directions for sub 2% inflation to return for quite a while.
What I am telling you is that as the pandemic has shown the folly in accessing far flung supply chains in search of cheap labor that many manufacturers of finished goods may seek shorter supply lines, and show some willingness to accept on a more permanent basis, a higher expense for the labor component that produces these goods. Should China, India and southeastern Asia produce less, and U.S. producers shorten these supply lines, this is a positive input for the middle and lower end of U.S. and North American income curves. This will also place support under inflation at a certain level.
In addition, as the move to transition from fossil fuels to renewable sources appears to be a sustained effort, at least across developed economies at this point, this will certainly become and remain an engine for headline level consumer level inflation. There is no way to cheaply transition from coal, oil and natural gas to renewable sources. We might save the planet, but we are going to pay a heck of a lot more to consume what will probably be far less reliable sources of energy.
On That Note...
... Keep in mind that what you and I see as 6.2% year over year inflation, the Fed probably sees as 3.6%, and that will not be updated until not this, but next Wednesday, the day ahead of the Thanksgiving holiday. You and I both feel the headline CPI print of 6.2%. The Fed, in their focus, sees core data, casting out both food and energy prices, which is where the real heat has been. October core CPI printed at 4.6% year over year.
In addition, the Fed focuses on PCE, not CPI, and PCE has always run substantially cooler than CPI. Next Wednesday, we'll see October data for PCE inflation. That core number for September hit the tape at 3.6% and there is no guarantee that the October print will hit the tape anywhere near the 4.6% core CPI print. The Fed has long told you that they were willing to accept above target inflation for a time. Just think like the FOMC for a minute or two. Knowing that such forces as supply chains and labor markets are likely to 'un-kink" substantially within nine months or so... how willing are you to panic in terms of changing your base narrative in response to anything that prints with a "Three" handle? "Six" handle? Sure, but that's our story, not theirs. They still see a "three" handle.
Elevated oil and gasoline prices here in the U.S. are not part of core and for the most part, a self-inflicted wound forced through policy error created at the Executive level, not one made at the monetary level. The FOMC is not about to panic.
It would appear, according to data released by Johns Hopkins University, that the national seven day average for new COVID infections has bottomed around 70K infections per day and is working itself back up again, reaching closer to 80K new infections by Friday. As the weather across northern climes has forced folks back inside and as children have, through no fault of their own, been slow to vaccinate, the numbers are back on the rise. Even in highly vaccinated regions.
Nationally only about 1/3 of those over the age of 65 who had been what was once considered to be "fully vaccinated", have been boosted. We now know that protection through vaccination ebbs somewhat after only a few months. Speaking on CBS News over the weekend, Treasury Secretary Janet Yellen - who kind of took a pass when offered another chance to support Jerome Powell for a second term as Fed Chair - said, "The pandemic has been calling the shots for the economy and for inflation." She added.... "If we want to get inflation down, I think continuing to make progress against the pandemic is the most important thing we can do." Unfortunate truth.
Kings of Retail
Retail giant Walmart (WMT) reports this Tuesday morning. Rival Target (TGT) reports on Wednesday. We have already heard from Amazon (AMZN) , while Costco (COST) remains more than three weeks out. Expectations are for EPS of $1.40 on revenue of $135B. These numbers would be up modestly from $1.33 on $134.7B for the year ago period. After trading at a forward looking earnings multiple of 24 to 26 times all year, these shares have been experiencing some weakness of late, and now trade at 22 times these forward looking earnings.
Fundamental analysts will be watching for a continuance of the trend over recent quarters toward closing the negative discount that current assets have held in posture versus current liabilities. What pragmatists will want to hear is how the firm is addressing labor shortages, higher labor costs, and kinked up supply lines. Investors will want to hear more about this supposedly chartered fleet of smaller cargo ships that will be able to bypass the U.S. West Coast ports, slip through the Panama Canal, and feed U.S. railroads through ports up and down the Atlantic coast.
Readers may see the base that I see between $135 and $152. Readers may also see a double top reversal in action, which would be bearish. My doubt there is that the trough might just be too deep to legitimize the double top. I also see the unfilled gap between the $142 and $143 levels, and a daily MACD that has just turned negative, while neither the RSI (Relative Strength Index) or FSO (Full Stochastics Oscillator) is technically oversold just yet.
What this tells me, being long the name, is that WMT may come in just a little bit going into or coming out of earnings, but that the move will not quite be as awful as a true double top might suggest. This potential mild form of weakness might just be an opportunity to initiate or add to this name. That said, there is also a chance that the 21 day EMA ($147.60) holds after surviving a test last Friday.
My Plan for Walmart
- Target Price: $180
- Pivot: $152
- Add: $145 down to $142 (50 day SMA down to bottom of unfilled gap)
- Panic: $140 (failure of 200 day SMA to hold)
Economics (All Times Eastern)
08:30 - Empire State Manufacturing Index (Nov): Expecting 21.6, Last 19.8.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)