Wall Street is back in rally mode … but does the health of earnings and the U.S. consumer warrant it? … diving into the real health of the consumer … all eyes on Jackson Hole
Wall Street has been in a partying mood for the last two months.Even the slightest bit of good news has proved enough to pop the cork and let loose. You’ve probably felt this, but there’s also data to back it up. FactSet, which is the go-to earnings data analytics company used by the pros, reports that the S&P 500 companies that have reported positive earnings-per-share surprises have enjoyed much larger price increases than usual. From FactSet:
Companies that have reported positive earnings surprises for Q2 2022 have seen an average price increase of 2.1% two days before the earnings release through two days after the earnings release.This percentage increase is much larger than the 5-year average price increase of 0.8% during this same window for companies reporting positive earnings surprises.
Yesterday brought two additional boisterous reactions to good-but-not-blowout earnings.Home Depot reported earnings that beat analyst expectations. The company also maintained its sales forecast for the year. Plus, on the earnings call, executives said that they weren’t seeing customers trading down to less expensive brands. It was a solid earnings call, though hardly earth-shattering. But Home Depot’s stock soared 4%, a big move for the massive company. There was also Walmart, posting analyst-beating earnings. And even though it echoed the same profit-warning it provided last month (inflation-pinched shoppers are, in fact, becoming more cost-conscious), the retail giant maintained its forecast for the rest of 2022. Wall Street loved it. Walmart stock shot up 5%. Today, Target reported a big earnings miss, but everyone knew it was coming. And Target’s guidance was relatively upbeat. The stock is down only 2.7% as I write. Party-hearty Wall Street is looking at these reports and saying “shoppers are still in the game. Inflation is on its way out. We’re going to dodge the worst of this.” That may be true – I hope it is. But even if so, we can’t come to that conclusion based solely on earnings reports like those from Home Depot and Walmart. To project what these stocks are going to do next, we need to look closer at the health of the purchasers themselves – and how these purchases are being made. I know that’s a little confusing. Let’s dig into the details.
Retail sales are holding up but are they hiding growing consumer weakness?
Every commentary I read about retail spending boils down to this:Shoppers are still spending. We’re going to be okay! But let’s back up and follow some breadcrumbs… The name of the game on Wall Street is “earnings.” Sure, stock prices can bounce all over the place on any given day due to countless influences. But long-term, what drives stock prices are earnings. And where do earnings come from? Well, from consumers like you and me, and the amount we spend on goods and services. Now, the money we spend can come from disposable income – in other words, free cash flow that’s left over in a family budget after all expenses are paid. Or it can come from savings and debt – think rainy-day funds and credit cards that enable spending, even though the consumer doesn’t actually make enough money to buy those goods and services from their paycheck. Obviously, the first source of funds for spending is healthy. The second, not as much. So, if we’re going to celebrate the fact that consumers are still shopping today, might it be wise to analyze where these dollars for purchases are coming from? In other words, what’s the shape of the average U.S. consumer? And what does that mean about buying behavior looking forward? From CNN Business earlier this month:
Americans are piling up credit card debt as they struggle to keep up with the high cost of living.US household debt surpassed $16 trillion for the first time ever during the second quarter, the New York Federal Reserve said Tuesday. Even as borrowing costs surge, the NY Fed said credit card balances increased by $46 billion last quarter. Over the past year, credit card debt has jumped by $100 billion, or 13%, the biggest percentage increase in more than 20 years… Not only are credit card balances rising, but Americans opened 233 million new credit card accounts during the second quarter, the most since 2008, the NY Fed report found.
Now keep in mind, this credit binge is happening during a rate-hiking cycle. Higher rates from the Fed will translate into higher interest rates on credit cards. And that means more money from consumer pocketbooks going toward interest payments…which leaves less to buy actual goods and services.Meanwhile, in June the personal savings rate fell to 5.1%, according to the Bureau of Labor Statistics. That’s the lowest since August 2009.
So, what’s the real condition of the U.S. consumer?
If you listen to a politician or perhaps a banking executive with an agenda, you might hear something along the lines of…“Yes, consumer debt is up. But what’s really happening is most of this debt is due to mortgages from more expensive homes. But overall, that’s a good thing. People owning homes is a great way for the average American to begin building equity wealth.” Yes, mortgage debt is a big part of this situation, but it’s not just mortgage debt that’s piling up. From the Federal Reserve Bank of New York, earlier this month:
In total, non-housing balances grew by $103 billion [in the second quarter of 2022], the largest increase seen since 2016.
Of course, that same report quickly reverts to damage control, reassuring the reader:
The share of current debt transitioning into delinquency increased modestly for all debt types but remains historically very low.
Okay, that’s good news, but how is that number trending? Remember, the name of the game on Wall Street isn’t “what’s here now,” it’s “what’s coming next.”As one example, a recent report from Automotive News finds that 1.63% of auto loans haven’t received a payment in at least 60 days. While that doesn’t sound like much, it’s the highest reading in the past four years. Okay, but that’s just one corner of the economy. Plus, it doesn’t mean these car-borrowers will default. So, let’s look broader. From PBS:
Long lines are back at food banks around the U.S. as working Americans overwhelmed by inflation turn to handouts to help feed their families.The Phoenix food bank’s main distribution center doled out food packages to 4,271 families during the third week in June, a 78 percent increase over the 2,396 families served during the same week last year.
And this is from Fox News:
“The traditional homeless person in need represents a very small percentage of the population that are actually getting food from the food bank network across the country,” [Andrew Olsen, president of Altus Marketing] said.“Most often it’s single families, it’s retirees, it’s people who are just down on their luck. The changing demographic of need has much more become families.” [Jorge Lupercio, Director of Operations at Placer Food Bank] said that the “biggest thing” that stands out to him is that “food banking is no longer a temporary service” but rather a permanent fixture in many households. “What we’re seeing now is that it’s actual working families that, even though the parents work and sometimes even some of the family members contribute, it’s still not enough,” Lupercio said.
And in case you’re thinking that these stories aren’t representative of the wider population, a recent survey from the Census Bureau found that four in 10 Americans say it’s somewhat or very difficult to cover usual household expenses. That’s the highest percentage since the question was first asked in August 2020.Bottom line: There are emerging inconsistencies about the health of the U.S. consumer. But it seems Wall Street isn’t as interested in this detail, and instead, is happy to look at the headlines which tell us that Americans are still spending.
Coming full circle to earnings
So, right now, retail earnings are fair. And overall spending by the average U.S. consumer is holding up. But we’ve called into question the underlying strength of the consumer.So, what’s the risk? Well, as we’ve noted before in the Digest, today’s “healthy” consumer who is still spending (though increasingly on credit cards and with savings) could be revealed as the financial “emperor with no clothes” later this year. At some point, the financial pain could grow too great, resulting in fewer purchases – regardless of whether those purchases are fueled by free cash flow or debt. And fewer purchases would mean that today’s earning estimates are too high. As we’ve noted here in the Digest, famed investor Louis Navellier has noticed earnings estimates already coming down. While he’s still bullish on specific corners of the market, he’s far more selective given these emerging pockets of earnings weakness.
The hope is that inflation truly has peaked and will fall at a brisk pace
That’s the silver bullet that will end this whole thing.It will help millions of cash-strapped American families while also taking pressure off the Fed to keep hiking rates. But erring on the side of “better safe than sorry” as it pertains to inflation would mean the Fed will continue with its recent history of 75-basis-point rate increases at the next Fed meeting. And let’s not forget, the Fed wants some weakening from the consumer to help bring down inflation. Of course, higher rates will continue to hurt lower-income Americans who are already standing in food lines and racking up credit card debt. Not to sound insensitive to anyone struggling, but for investors, the question is: At what point does “good” consumer weakening (which brings down inflation) become “bad” consumer weakening (which hurts earnings across the board)? We’ll be looking for clues from the Fed next week, when the Federal Open Market Committee holds its annual symposium in Jackson Hole, Wyoming, featuring commentary from Federal Reserve Chairman Jerome Powell. In the meantime, despite today’s pullback, Wall Street is partying. Let’s party with it. Have a good evening,