If the consumer won't cooperate, we've got a problem
After a panic event, it’s human nature for consumers and investors to be stubbornly cautious for quite some time. While the market seems to be pricing in a recovery starting this summer, the longer it takes workers to get back in jobs, the more negative the impact on consumer spending. People immediately cut spending by 10% when they become unemployed, Deutsche Bank says, and if they remain jobless until their unemployment benefits expire, their spending falls 20% to 30%. As more states and businesses reopen, surveys show a majority of Americans think it is still too soon. Still, the pace of decline in same-store sales is easing, Redbook reports, with “more customers turning to online shopping, in-home delivery and curbside pickup.” Hotel occupancy doubled this past weekend in some beach markets in Florida, Texas and South Carolina. Michigan consumer sentiment surprisingly ticked up the first few weeks of May, and home-buying demand appears to be reviving all over. Mortgage purchase applications jumped almost 11% this past week, the fourth consecutive weekly increase, and have now recouped about two-thirds of their mid-March decline. This is admittedly early good news from a consumer who has been frugal since the global financial crisis more than a decade ago. Indeed, the household savings rate rose from 2.5% in 2006 to 8% in recent years and 13% in March as the economy was closing. Though states are opening across the country, people over 55—who account for 40% of consumer spending—are supposed to continue to shelter! Ultimately, the virus and unemployment rate will dictate consumer behavior. Plus human nature.
After moving sideways for a month, the stock market has wobbled with sober comments this week from famed investors Stan Druckenmiller and David Tepper, as well as Fed Chair Powell (more below). Add in the Tesla controversy over its LA opening, and Fundstrat says it’s understandable markets may want to “take profits” and reset sentiment. It sees a battle taking place between two key Fibonacci retracement levels off the March low, at 50% and 62%, respectively (2,793 and 2,934 on the S&P 500). Strategas Research reports that drawdowns following the initial rally off major market lows historically average around 10%, putting first support at roughly 2,725, followed by 2,575. Investor sentiment remains extremely dour, with 50% of retail investors (who, also, are consumers) expecting stocks to drop from current levels, according to the American Association of Individual Investors weekly survey. At past similar levels, stocks have proven to be great buys, Ned Davis says, with 12-month S&P performance averaging 21% and positive 100% of the time, with the exception of 2008. Recent trading suggests the beta rally may be cooling but appears to have some gas left in the tank, Strategas says. A common worry running through bearish arguments is a “second wave” will lead to weak economic growth at a time equities are discounting a faster recovery.
When it comes to earnings, from which the market is ultimately priced, what really matters is 2021. The Lehman collapse was more bearish than this crisis because it occurred late in 2008, depressing 2009 estimates, which had a much greater weight in calculating forward earnings. Because the current crisis occurred early in this year, it has weighed more on 2020 estimates: thus 2021 and 2022 estimates haven’t been downwardly revised anywhere near the level for the current year. Analysts expect year-over-year (y/y) earnings to decline by nearly 40% in Q2 and 26% for all of 2020 to about $127 earnings-per-share (EPS), a figure that keeps changing. The question is how much longer can high-quality growth stocks keep supporting the market in a period of zero EPS visibility? And with heretofore unfathomable stimulus supporting the market big time, what about the piper? Empirical Research believes the biggest threat to what had been record profit margins is higher tax rates as governments around the world find themselves in dire need of revenue, bringing an end of the race to the bottom in corporate tax rates. At the moment, the market is pricing 17 times 2021 bottom-up estimates, in line with its average multiple over the last five years. Taken together, the estimates match the 2019 S&P earnings number, even with the energy and financial sectors that are expected to be far below pre-pandemic levels. All of this is predicated on a recovery that we expect will start in the second half but be sloppy. One metric to watch in our consumer-led economy is consumer durables. Recessions are dominated by sharp cuts to inventories and dramatic drops in spending on durable goods such as autos and appliances. Now, I am a good consumer, receiving packages almost daily while quarantined. I just ordered a very pricey Jura coffee maker to replace my $100 Keurig. Wow, I’m going to have to avoid Starbucks for quite a while to justify my purchase to the Mister. This had better be a durable consumer durable!
- Credit is supportive The most unifying indicator between the equity market and earnings bottoms—credit spreads and investment-grade (IG)/high-yield (HY) issuance—is healthy, with investor inflows into IG and HY bonds remaining firm. Jefferies says there is a very strong coincident correlation between HY credit spreads and lending standards as represented in the Fed’s monthly survey of senior loan officers, with these measures suggesting the worst is over for the credit recession.
- With no guidance, ESG comes in handy One critique of Environmental, Social & Governance (ESG) investing is it’s just another way to screen for quality. That may be, but Bank of America finds it to be the best measure of future quality. It says ESG provides a better signal of earnings volatility than standard return-on-equity or debt-to-equity gauges, and serves as a good screening tool for avoiding bankruptcies. It also notes ESG funds have seen record inflows over the last 15 weeks.
- There’s an army working on this More than 100 different Covid-19 vaccine candidates are in various stages of development, with eight already in human trials. This has experts “cautiously optimistic” that the world will get a vaccine, according to a Salt Lake City newspaper report. “They just don’t know when.” Testing and approvals take time, but this time, all hands are on deck. In the past, vaccine development was “measured in decades—not months, with each step taking years, not weeks.”
- April is the cruelest month Retail sales plunged by a more than 16% month-over-month and 21% y/y, both records, as shutdowns and stay-at-home orders kept customers away. April industrial production and manufacturing plunged the most on record, sending industrial capacity to an all-time low. Economists expect April will be the ugliest month for macro data.
- My grocery bill hasn’t gotten smaller April’s drop in core CPI marked the largest sequential decline on record with data going back to the late 1950s. But actual deflation likely was overstated as a plurality of retail locations where the government gathers info were closed. The consumption basket of households has shifted violently, with people buying more food from the grocery stores, more gym equipment, etc., while foregoing spending on restaurants, hotels, etc. In fact, prices of food from home are rising.
- A narrow market is a vulnerable market Only 17% of stocks are trading above their 200-day moving average. Considering how far stocks indexes have rebounded, this is a “pathetic number,’’ Cornerstone Macro says, that's representative of how narrow the rally has been.
Japanification? In warning what could come if the country doesn’t continue to aggressively combat the Covid crisis, Powell’s comments this week reflected the epitome of “Japanification”—low investment, low productivity and stagnant incomes that lead to an even lower neutral rate, trapping the federal funds rate at zero for an indefinite period of time.
Inflation or deflation? Neither is good The Covid recession has global government debt surging and central bank balance sheets exploding—dynamics that historically have led to big increases in inflation. This didn’t happen after the global financial crisis but back then, the number of workers per dependent was rising. Now, the opposite is happening amid a growing number of retirees who no longer contribute to the workforce but continue to consume. This suggests aggregate supply will lag aggregate demand, the kind of supply shock that’s inflationary.
Virtual girl still adjusting Skype, Skype for Business, Zoom, Microsoft Teams, WebEx and my head is spinning. Since my sales colleague suggested we simply dial in to this week’s WebEx meeting, you can imagine my panic at go-time when I was asked to turn on my camera, with no makeup (unprecedented, sigh) and don’t-want-to-talk-about-it hair! But in the end, no problem—turns out I’m a natural beauty!