Discover more from Banking on the Market
The Weekend Edition # 36
Inverted Yield Curve, SPR Release, Sector in Focus: Consumer Discretionary, Earnings: Nike, RH
Welcome to another issue of the Weekend Edition.
Thank you to all who’ve read and subscribed to the newsletter this week!
Here’s what we cover this week:
Market Recap - Inverted Yield Curve, SPR release, VIX
Sector of the Week - Retail / Consumer Discretionary
Earnings - Nike & RH
The Week Ahead - What I’m watching
Closing Thoughts - Mixed Signals
Let’s dive in ⬇️
Market Recap - Mar 28 - Apr 02, 2022
There’s been way too much excitement in the last two weeks. But then again, when are the markets not exciting!
Indices and Volatility
The bears got their face ripped off as they say, and the all the indices marched higher for 10 straight days without much reprieve. Part of the reason was also Tesla moving higher on the news of another potential stock split.
We’ve only started to see a bit of reversal on that upward trend in the last three days but, perhaps much of that was associated with the month-end/quarter-end rebalancing. All the indices have crossed above their 50-day moving average but still remain below the 200-day. And we’re still over 10% down from a 52-week high on the Nasdaq.
On a positive note, volatility has retreated with the Vix dropping even below 19 during the week before settling at 20. It would seem that the markets are still choppy and traders are deciding whether we’re seeing a meaningful reversal to start a new bull run or whether this is just another bear rally.
Rates & Bonds
The Yield Curve inverted just as predicted but, still sooner than anticipated. We’re still seeing some movement between flat and inversion, as rates are very close to each other. Bond yields on the short-end soared while the 10s and 30s came down meaningfully. With the curve inverting, bank stocks (particularly lending banks) have begun to decline.
Over the last weeks, bonds have seen the largest amount of outflows in the past few years which is further exacerbating the situation. The bond market usually leads equity markets but, the past few weeks seems to have had a semi-permanent divergence. While the Vix moves down, the volatility in bonds or the MOVE index continues to remain is elevated.
The big news this week was the US releasing oil from their Strategic Petroleum Reserve (SPR). WTI dropped immediately on the news. The oil producers however, remained elevated. This pull back in oil may be short lived, as the reserves are set to be released in May and eventually will have to be replaced.
Sector in Focus - Retail
I’ve been saying comps are getting challenging. It’s not just me. Most analysts have the same view.
Stimulus payments led to a huge increase in disposable personal income. In terms of the statistics, people were actually much better off than before the pandemic, human tragedy aside of course.
So what’s changing now:
The stimulus payments are gone and disposable personal income has reduced by -16% from the peak in Mar 2021.
Worse still, real disposable personal income is reducing more rapidly because of inflation. You can see the divergence in the curves above and the change from the peak in Mar 2021 for real disposable income is -20%.
Goods spending has reduced by shifting to services as the economy begins to re-open. The last PCE report for Feb 2022 saw a decline in spending for goods by - $58.9B while seeing an increase of spending for services by $93.8B. People are not sitting around at home and ordering stuff anymore!
Costs are increasing. This week’s jobs numbers show a Month on Month increase in wages and if you listen to earnings calls, all you’ll hear is the rising cost of labor, freight, and raw materials.
We will start to see inventory build-up and obsolescence. As consumer demand drops for discretionary goods and liquidity starts to decrease in the economy, retailers will be left with inventory that they can’t get rid off quickly enough. Watching the Inventory-to-Sales ratio is a key measure for this.
Earnings Revisions (from FactSet)
The Consumer Discretionary sector has recorded the largest percentage decrease in estimated (dollar-level) earnings of all eleven sectors since the start of the quarter at -11.9% (to $28.3 billion from $32.1 billion).
Q1, 2022 EPS guidance is -10.8%
Current Year 2022 EPS guidance is -2.4%
Profit Margins will also see a meaningful downward revision.
Consumer Discretionary is one of the worst performing sectors when inflation is high and economic growth is slowing down, not to mention the Fed tightening. Retailers in particular are likely to get hit both on the topline and bottom line. The next two quarters will certainly be tough before we see some improvement perhaps in the back-end of the year. At least, this is what the sector themselves are guiding.
Nevertheless, there are still companies who are strong enough with key attributes to withstand this environment.
For now, I have long Nike and RH, which I cover below and short Nordstrom (JWN).
Earnings - More Retail
Quite a few of the retailers reported over the last couple of weeks. As the previous section makes clear, retail will be a challenging area as we head into the changing macro landscape.
Nike had a great quarter and their Direct-to-Consumer strategy is working really well driving up Gross Margins by 1% to 46.6%. They’re gradually moving away from most of the wholesalers but will stay on with a few of the larger ones such as Foot Locker. I’d assumed that the stock would take a hit with Covid cases surging in Vietnam. But quite the opposite, as they assured everyone that everything was up and running:
“All factories in Vietnam are operational, with total footwear and apparel production in line with pre-closure volumes and our forward-looking demand plans. Nearly all of our supplier base is operational without restrictions, and we are working closely with our partners around the world to navigate through the most recent risks related to COVID.”
Nike however, continues to struggle in China with Revenues still down -5% on a YoY basis. However, last quarter they were down -20% so, that’s a remarkable improvement. With major Covid lockdowns in China this quarter, I think we will continue to see revenue decline there.
Restoration Hardware (RH)
RH had quite the sensational earnings call and by now, I’m sure you’ve already heard about it. Their CEO is a bit on eccentric side and he laid out a doom and gloom scenario for the months ahead. He’s bold to do that and he also said he realizes that his stock would take a hit.
The company missed estimates and guided down for FY 2023. Understandably so. Overall, discretionary spending will suffer. The cost of inputs was also a factor with freight costs almost doubling for the company. Nevertheless, the company’s adjusted operating margin still improved by 1.5% to 25.2% and they still wield pricing power over their affluent customer base. RH also announced their intention for a 3-for-1 stock split.
The stock dropped -13% on the earnings result and now the P/E has come down to close to 12x. I’ve liked this company for a long time and I will be keeping it on my watchlist to re-enter.
The Week Ahead
A rather light week but with the FOMC minutes coming out on Wed, and several Fed members speaking throughout the week. We know this can end up moving markets.
Not much in the way of earnings for next week. It’s the last few before we head into the beginning of a new earnings with the banks starting on April 13th. Time flies.
This week I'm looking at STZ, CAG and LW. Both are sure to report some interesting stats given the rising cost of food.
What I’m watching
With the rally we’ve had, it’s tough to say where the market is going. Overall, the market is sending mixed signals. Stocks, Treasuries and Commodities seem to be signalling a very risk on environment. On the other hand, high yield debt and sector preferences like Utilities and Consumer Staples signal a very defensive market.
We will see what next week brings.
Here’s wishing you a happy weekend and safe investing.
Ayesha Tariq, CFA
There’s always a story behind the numbers
None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have a long position in $NKE, $TLT and a short position in $KRE, $JWN as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.