by Shawn Narancich, CFA
Executive Vice President
Equity Research and Portfolio Management
Threading the Needle
Further evidence of slowing inflation amid moderating retail sales lent additional credence to the economic soft landing narrative this week, exactly 18 months after the Federal Reserve began raising interest rates to combat high prices. Meanwhile, retailers book-ended third quarter earnings season in generally encouraging fashion, putting finishing touches on a surprisingly upbeat reporting period that now tallies positive revenue growth for the S&P 500 and over 6% earnings per share expansion. All of which was greeted warmly by investors who bid up equity prices this week, adding to recent gains that now have blue chip stocks up over 7% in the month of November. Bonds also rallied, dropping the benchmark 10-year U.S. Treasury yield to 4.44%, down considerably from the 5% level notched nearly one month ago.
The Exalted Shall Be Humbled
While all major retailers reporting earnings this week delivered earnings at or above expectations, discrepancies in guidance accounted for widely divergent stock price reactions. Both Wal-Mart and off-price leader TJ Maxx delivered beat-and-raise quarters (with both reporting top and bottom line growth), but in both cases, implied fourth quarter earnings guidance lagged Wall Street expectations, sending stock in the nation’s largest retailer down by 8% on Thursday and TJ Maxx’s stock down by 4% earlier in the week. Net of this week’s stock price performance, both retailers have outperformed their peer group this year as investors gravitate to later cycle themes of everyday value and off-price merchandising. In contrast, unperforming retailers Target and Home Depot reported more encouraging guidance that was met with a positive investor response in both cases, especially for the embattled Target, whose stock rose 18% in response to a large earnings beat and considerably higher fourth quarter earnings guidance. Across the peer group, retailers are reporting upside to gross margins tied to lower freight and logistics costs, still troublesome but less impactful levels of inventory “shrink,” and cleaner inventories that are resulting in fewer markdowns.
Holiday Cheer on Tap?
Notwithstanding the small 0.1% month-to-month decline in retail sales reported by the Commerce Department this week, the first sequential pullback since March, we continue to note a healthy U.S, consumer who is gainfully employed and ever prone to spend what he or she earns. Accordingly, the National Retail Federation estimates a 3-4% gain in 2023 holiday sales, about a percentage point below last year, but still offering key support to an economy that to this point has defied nearly five and a half percentage points of interest rate increases by the Federal Reserve since March of 2022. While we don’t expect the U.S. economy to match its 4.9% GDP growth reported recently, economic activity continues to expand in the fourth quarter.
That’s a Wrap
In addition to October retail sales that outperformed expectations for a larger drop, the Consumer Price Index (CPI) reported this week was also encouraging. At 3.2%, the CPI was lower than expected, dropping from 3.7% in September and four and a half percentage points below where it was a year ago. In addition to the positive reception with which stock and bond investors greeted the report, expectations for a December rate hike all but evaporated and interest rate futures promptly boosted odds of a Fed interest rate cut by May to better than 50%. We now believe that the Fed is done raising rates for this economic cycle.
A Soft Landing . . . Remains to be Seen
A key question now becomes whether economists’ consensus expectation for no recession in 2024 will be realized, contradicting the annals of economic history that would argue against it. So far so good, but as we’ve advised, the best course of investing action is likely to employ both caution and patience in deploying capital at this point.
Our Takeaways from the Week
Stocks and bonds rose, adding to recent November gains in both
Economic data and earnings continue to thread the needle, but only time will tell whether the U.S. economy ultimately skirts recession next year