Week of Aug 15, 2022

Opening Remarks:

Last week’s close (week of Aug 8) marked the fourth consecutive week of growth in S&P500 index. Given the momentum that has been built, it appears that the market has appetite for higher prices. Interestingly enough, some influential players indicated that this rally might continue until year-end with high year-end targets. JP Morgan is expecting the S&P500 index to rise to 4,800 by the end of this year (currently at 4,280) [follow-up note: not all departments of JP Morgan hold this view]. Obviously, there are some that disagree, namely, Morgan Stanley and Bank of America which expect the S&P500 to be at 3,900 and 3,600 by year-end, respectively.

There are a series of indicators and earning reports scheduled to be released this week. The earning reports will give us a sense of retail companies.

Outside of North America, the economic conditions are not optimal, making the US comparatively more attractive to investors. In China, the PBoC (People’s Bank of China) cut rates by 10bps in a surprise move. Although the economic downturn in China is concerning, it appears that at least part of it is by design. The government of China explicitly indicated that they don’t want people to speculate on the housing market. In their view, houses are for living and not for speculation. They believe that the housing market in China is in bubble territory and want to let the ‘air out of the bubble.’ This is why you don’t see a strong reaction from authorities to the mortgage crisis. The other contributing factor to China’s slower economy is the troubles in Europe where a considerable amount of China’s exports are destined to. The last piece of information out of China is the high unemployment rate among youth which peaked this month.
In light of China’s economic troubles, the yuan lost value against the USD. Overall, many expect China’s unfavorable economic conditions to continue but not having a significant adverse impact on the global economy.
The VIX Index is still below 20 today. As indicated in our last week’s post, this is an index we have our eyes on as it might increase significantly when the Fed makes it clear that they will continue with the rate hikes (in our opinion).

Monday, Aug 15, 2022

Empire State Manufacturing Survey, conducted by the Federal Reserve Bank of New York, was released today. This survey tracks the manufacturing expectations in the state of New York. The survey is sent to 200 manufacturing companies (CEO or President), and usually, they received 100 responses back.
This is not a primary indicator and does not carry much weight (it’s only for one state), but the results were quite surprising, and the language that was used to describe the results in the report was gloomy. Here are some excerpts:
“Business activity declined sharply in New York State, according to firms responding to the August 2022 Empire State Manufacturing Survey. The headline general business conditions index plummeted forty-two points to -31.3, the second largest monthly decline in the index on record, and among the lowest levels in the survey’s history.”
“The new orders index dropped thirty-six points to -29.6, and the shipments index plummeted nearly fifty points to -24.1, indicating a sharp decline in both orders and shipments. The unfilled orders index fell to -12.7, indicating that unfilled orders shrank for a third consecutive month. The delivery times index declined to around zero, indicating that delivery times held steady, the first month they have not lengthened in nearly two years. The inventories index fell to 6.4, signaling that inventories increased marginally.”
An interesting observation is a dichotomy in the economic outlook. 12% of respondents reported that conditions have improved over the month, and 44% reported that conditions had worsened. Interestingly, we can observe this duality in many aspects of the economy today, including the impact of inflation. While some are feeling the pain of inflation, some don’t even notice it. This type of situation usually makes policy-making difficult.

The forward-looking indicators (the expectation for 6-month ahead), including general business conditions, new orders, and shipments improved slightly from the previous month. That being said, the capital expenditures and technology spending reduced marginally.
Overall, this index signals some turbulence ahead.

Takeaway: High uncertainty about the future of the economy continues with no significant impact on the overall market prices. The possibility of a recession is rising and more economists are convinced that there will be one in early 2023. Investors are acting as if a recession is priced in the valuations, but in reality, it has not.

Tuesday, Aug 16, 2022

Oil prices are coming down, but it hasn’t translated to lower gasoline prices in Europe. The gas prices in Europe are up around 12 times the seasonal average in the last 5 years. The story is a little more positive in the US where the gas prices are coming down.
Another story that is developing is the nuclear deal with Iran. It appears that despite the conflict among world powers, they have the willingness to reconcile their differences and reach an agreement. Should that happen, a good amount of crude oil will be available to the markets, just ahead of winter.

Note: the fiscal year for both Home Depot and Walmart is from Feb 1 to Jan 31. Therefore, the Q2 results relate to May, June, and July.

Home Depot released its earnings. For the 3 months ending July 31, 2022, compared with the same period a year ago:
- Net Sales $: increased compared to a year ago by 6.5%
- Gross Margin %: was 33.4% compared with 33.6% last year.
- Operating expense: increased by 3.5%
- Operating income: increased by 8.6%
- Interest expense: increased by 16.9%
- Customer transactions: decreased by 3% (number of transactions, not the $ amount)
- Average ticket: increased by 9.1%
- Sales per retail square foot: increased by 5.7%
Noteworthy in the above stats is the fact that the number of transactions decreased but the average spent by an individual increased compared with the prior year. This indicates fewer visitors to the stores, but those who go to stores, spend more (which is a function of inflation and the desire to spend more).

Walmart released its Q2 earning reports. Highlights from the press release:
- Top line growth globally, partially driven by inflation. The increase was 8.4%, but considering the recent strengthening of the dollar and adjusting for it, the increase was 9.1%.
- Consolidated gross profit rate declined by 1.32% (part of the reason is the method of accounting used, so the entire decline is not because of the price pressure)
- Comparable sales grew 6.5% year-over-year
- Operating expenses decreased. Baked in this number is wage increases, which Walmart has referred to as “wage investments”.
- International sales increased 5.7%, mostly driven by Walmart’s three largest international markets: Mexico, Canada, and China.
- Sam’s Club membership income increased by 8.9%. Also, Walmart’s global advertising business grew by ~30%.
Noteworthy in the release are the following: 1) More middle to higher-income customers shop at Walmart, looking to save money as everyone is getting squeezed by higher prices, and 2) Walmart’s market share in groceries and consumables increased, with most of this change being driven by customers with an annual income of 100K+.
In a move similar to Amazon’s Prime, Walmart+ members can enjoy free streaming services as Walmart and Paramount strike a deal.

Wednesday, Aug 17, 2022

The US Census Bureau announced US retail & food services sales for July 2022. The advance estimate showed no difference from the previous month but 10.3% increase over July 2021. Below is a summarized table, recreated from the data published on the US Census Bureau:

Source: US Census Bureau
Note: 2022 figures are adjusted for seasonal variation and holiday and trading-day differences, but not for price changes.

As shown above, the overall month-over-month change is negligible. This is a combination of increases and decreases. Most notably, spending on cars, gasoline, and clothing decreased while spending on home furniture and building materials increased. Spending on food, health, and electronics increased marginally.

Target (TGT) released its earnings today.
- Comparable sales grew 2.6%, reflecting strength in food & beverage, beauty and household essentials.
- Store sales increased 1.3%
- Digital comparable sales grew 9%
- Cost of sale was up 16.6%, which eroded the net earning by 90%.
Inventory management was the root cause of the disappointing results, causing the share prices to drop. The guidance for the remainder of the year is just a meager growth and slightly better profit margin.
As summer ends, the retailers should prepare for Christmas sales, which constitutes a majority of their annual sales. Building up inventory takes approximately three months. Analysts believe that there in order to make room for the arrival of the new inventory, retailers should sell their excess inventory through more aggressive sales.

Thursday, Aug 17, 2022 & Friday Aug 18, 2022

S&P 500 index dropped by 1.3% on Friday. This was partially due to the rhetoric from the Fed governors who repeatedly reaffirmed that tackling inflation is a priority. Another contributor was the fact that Friday was standard expiration date for options.
Meme stocks also came under pressure as the retailer Bed Bath and Beyond (BBBY) lost almost 40% of its value on Friday, which came after a 20% loss on Thursday. Prior to this decline, BBBY price raised from ~$5 to $23. The catalyst for the selloff was the news that Ryan Cohen sold his position in this company.

Source: Yahoo! Finance
Interval: 1 hour. Note the significant drop on Aug 19, 2022.

Closing remarks

This week definitely was not a good week for meme stocks for BBBY plunging significantly. Overall, it appears that markets are starting to take the Feds more seriously, evidenced by a correction in the market. Next week, we will have the earning reports for banks. In our opinion, some of them are undervalued. But we should see this in the backdrop of a possible significant correction in the market. Keeping that in mind, we find the following stocks attractive:
ME, GILD, RTL, KIM, PBR