For those of you who would prefer to listen:
There is a keen focus on the American Consumer these days. With inflation at 4-decade highs and the Federal Reserve spiking interest rates, the US Economy is slowing to stall speed. Consumer spending accounts for roughly 70% of US GDP (Gross Domestic Product). Needless to say, the American Consumer is the economic engine. So far, they’re hanging in there.
Americans seem to have started spending for the Holidays. Amazon held its first-ever October Prime Day and many retailers have already initiated Black Friday sales. October retail sales were reported this week. The headline number came in hotter than expected and September was revised upward. Retail sales in October rose 1.3% month-over-month. That beat the estimate of 1.0%. It was the largest monthly increase since February and was up a whopping 8.3% from a year ago.
These numbers sound fantastic on the face of it. But it depends on how you look at it. Headlines can be quite misleading. Remember, inflation has been running near 8% this year. Higher prices have been the biggest driver of the spending increases. Units sold in October was basically flat. We Americans have been spending more and getting less. Consumers are stretched. That’s been a big theme in 2022.
It’s important to remember that throughout the first 2 years of the pandemic, Americans were spending wildly on goods and supply chains could not keep up. Discounts were absent. Savings rates skyrocketed with government checks building up as Americans were stuck at home. Spending surged on home décor and remodels, more casual wardrobes and all things electronics. If you could get it, Americans bought it. Them days is over.
The National Retail Federation said this month that it expects Holiday sales to increase by 7% this year. That is below the current pace of inflation. With Black Friday now a week away, it is going to be critical for companies to quickly adjust to the changes in consumer behavior. Americans want deals. This week brought a slug of earnings reports for the Big Retailers, which always provide an even clearer look into the health of the American Consumer.
Walmart led things off. You know the slogan: America shops at Walmart. The Arkansas-based behemoth reported strong results. There were some important developments uncovered. More Americans went shopping at the low-priced leader. Walmart increased its customer base this Fall. It included higher-income consumers, those making $100K or more. There was also an uptick in traffic online. Walmart’s website has been a busy resource from coast to coast. 13% of total sales started with a digital engagement. Perhaps the biggest takeaway was that Grocery was the Walmart engine in Q3. Discretionary spending has been more subdued. Walmart is the largest grocery store in the country now too. Americans are looking for value. You find it at Walmart.
Sales in the United States increased 8.2% on the back of a 2.1% increase in transactions and 6.0% increase in average ticket. The Street estimated 3.8%. So, it wasn’t just inflation. Walmart sold more stuff, though it was generally at higher prices than a year ago. The company highlighted its strong grocery share gains and robust seasonal event sales in the form of Back-to-School and Halloween. Softness was seen in electronics and apparel. Perhaps most important was the company raised its 2023 outlook and announced a $20 Billion stock repurchase plan. That shows confidence. Walmart is often a beneficiary in an economic slowdown.
Home Depot had some interesting things to say. The average ticket rose 9.1%, while traffic declined 3.0%. Both sales and profits last quarter were stronger than the Street expected. But it was higher prices that offset a decline in the transaction volume. Again, paying more for less. An important takeaway: Americans are still spending on their homes. Despite the Housing slowdown, Home Depot saw strength in project-related categories. Professionals, mostly meaning contractors, saw an increase at the expense of the Do-it-Yourselfers.
The Big Box Hardware Store said its inventories were up 25% in Q3 vs a 5.6% increase in sales. That’s a problem, but it was an improvement from the 38% inventory increase in Q2. Excess inventory is a theme that seems to be gathering steam. There will be a lot of markdowns this Holiday season as retailers need to offload stuff ahead of the new year.
Target poured cold water on the Consumer rally as it lowered expectations for the Holidays. The Minnesota-based retailer beat the Street’s expectations for Q3 revenues but warned of sales hit from inflation and noted changes in consumer behavior. Profits were cut in half in the quarter. Target saw sales decline as families across the country contend with these higher prices. A key beneficiary from 2020 and 2021, Target is struggling in 2022.
Target management highlighted huge headwinds from inflation and the economic uncertainty. Target sells more stuff and less groceries. Americans are buying less stuff now. Walmart’s strength was Target’s weakness. It seems as though Target shoppers made a choice of what they need versus what they want. Target shoppers bought fewer full-priced items and appear to be holding out for better deals. They chose smaller items, value packs and generic brands to seemingly stretch their Dollars. That’s an important signal for the Holiday Season. Target’s stock got hit hard on the news taking other retailers with it.
Americans are taking on debt at the fastest pace in 15 years. Credit card balances hit $925 Billion last quarter. That’s just below the all-time high of $927 Billion reached in 2019. It’s a $120 Billion increase from a year ago when savings rates were much higher. This is the worst kind of debt, as credit cards charge as much as 20% interest. It’s no good. In case you’re wondering, New Jersey has the highest average credit card balance while Kentucky has the lowest. I was surprised that California was not even in the top 10.
Higher prices have soaked up the spending. Americans are plagued by inflation. Higher prices at the pump and grocery store are sucking Dollars away from other discretionary items. Mortgage rates have spiked and Housing prices have fallen. A 7% mortgage buys a lot less house. People are paying more for less. It’s felt throughout the system.
While prices rise, the number of jobs has started to fall. Big Tech has increased layoffs of late. Amazon is slashing its headcount. 10,000 positions will be axed, making it the largest-ever reduction at the company. Amazon has over 1.5 Million employees and was one of the biggest sources of job creation during Covid as the company stocked its warehouses and delivery vans to meet the surging demand. Amazon hired 800K people early in the pandemic, doubling its headcount. Job cuts have become a theme in Q3 and it’s a theme that’s gaining steam.
Bank of America’s latest Global Fund Manager Survey shows investors are still really negative. 73% of respondents expect the Economy to weaken over the next 12 months. 77% see earnings growth contracting in 2023. Tech has been the absolute darling for investors for over a decade. No longer. BofA says portfolios are currently the most underweight Tech since August of 2006. These are contrarian indicators. It suggests much of the negativity is priced in. The herd is seldom right. 2006 is when Tech finally recovered from the Dot-com bubble burst. Tech has been in a world of hurt in 2022. It’s been trying to rally of late.
There’s been a powerful move off the October lows. The S&P knocked on what I heard described as a rusty door at the 4,000 level. Rusty doors can be hard to get through at first. It takes time and some effort to loosen them up. It’s been 2 months since stocks have been through 4,000. The Fall rally has been impressive off the lows. The Market seems due for a bit of a breather as it recalibrates. S&P 4K holds some significance. Not only does it represent a psychological level, it also lines up with the 62% Fibonacci retracement between the August high and the October low. It’s also around the 200 Day Moving Average, which has been descending. Getting through it would be important. It may take a few hard knocks to eventually push through this rusty door level.
All this said, it’s still all about the Fed. The Market wants a pause. Retailers have made it clear that the American Consumer is slowing. The Fed has slammed on the brakes for the money supply which hit Housing first. It’s been felt everywhere. The Market believes the central bank’s tightening campaign has already done damage and further tightening runs the risk of breaking the Economy. The big risk is the Fed focusing on lagging indicators. They’ve gone to great lengths to combat inflation. Time is needed for it to work through the system. There’s still a chance that they overdo it. That’s the Market’s biggest concern, by far; Too much brake will lead to a break.
The yield curve is still inverted. In fact, what’s called the “recession spread” is the widest it has been in 15 years. That still suggests to us a recession is a lock in 2023. The spread between the 2-Year and 10-Year Treasury yields is over 0.7%. It is as wide as it was entering the 1981 recession. The fact is, the Housing Market is already in recession. That has broad implications. So many jobs and overall spending are tied to homes. Housing accounts for 16% of GDP. The Fed targeted Housing first. Jobs are generally next in line. People tend to spend less when their house value is going down. They really cut their spending when they lose their job.
I think it’s accurate to say, the Fed doesn’t want to see the Market rally right now as its business is unfinished. But the Market out-thinks and out-smarts everyone. It’s the ultimate leading indicator. Yields have fallen the last few weeks, indicating inflationary pressures are slowing. So is the US Economy. The Market forced the Fed’s hand to start tightening. It will force its hand to end it too. The only question is when. The next meeting is mid-December. Another ½-point hike is priced in. A pause likely comes early next year. The Market should like that.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
