Dark Clouds Descend
The stock market’s losing streak continued into May, as the Dow Jones Average lost 0.2%, its sixth straight declining week, while the S&P 500 also fell 0.2%. Once again, the losses were heavier in the Nasdaq Composite and the Russell 2000, which slid 1.5% and 1.3%, respectively. Both of those indexes are nearly 25% below their record highs from last November, and down double-digits over the last 12-months. The modest losses in the Dow and the S&P masked a turbulent performance that saw both the best and worst days since 2020. The week started with three straight positive sessions, with a fantastic rally Wednesday afternoon powered by Federal Reserve Chairman Jerome Powell’s news conference following the widely anticipated 50-basis point interest rate hike. During that conference, Chairman Powell took future 75-basis point rate hikes off the table, expressed confidence in the underlying strength of the economy, and predicted that the current spike in inflation would steadily abate as the year progressed. The Dow Jones surged over 1000 points as emboldened bargain hunters came out of hiding and short sellers scrambled to cover their positions. Thursday morning the tone turned negative as the airwaves were dominated by bearish commentary, with analysts casting doubt on the economy’s ability to avoid a recession; dark clouds once again descended on Wall Street, wiping out Wednesday’s gains entirely. That negativity was reinforced by a report Thursday morning that there was a staggering 7.5% decline in worker productivity in the March quarter, representing the biggest decline since 1947.
The bond market was equally bad, with the yield on the 10-year treasury rising 23 basis points to 3.12%, its highest level since November 2018. The dollar advanced to another multi-year high, while crude oil surged almost 5%, and gold slipped approximately 1.5%.
Most of the corporate earnings reports and economic data releases continued to paint a fairly rosy picture of economic strength of robust sales and demand, with earnings in certain sectors such as Consumer Staples and Consumer Discretionary and Industrials tempered by input cost and labor cost inflation. Following another week of positive earnings surprises, the earnings growth rate for the first quarter is 9.1% today, compared to an earnings growth rate of 7.0% last week and an earnings growth rate of 4.6% at the end of the first quarter (March 31). Approximately 80% of companies have beaten expectations, with particular strength in the Health Care, Utilities, and Financials sectors during the last week. Turning to the economic data, the jobs market remained clearly robust, with non-farm payrolls rising by 428,000 and the unemployment rate holding at 3.6%. In what could be viewed as a “Goldilocks” report, hourly earnings grew, but less than expected.
The Up & Down Wall Street column in this weekend’s Barron’s cautions investors not to adopt a Winnie the Pooh “everything will be all right” attitude, as that kind of thinking can get you mauled in a bear market. We continue to believe that over the long-term maintaining an appropriate allocation to stocks specific to each individual’s circumstances remains the best policy, despite the price gyrations that follow the pendulum swings between Greed and Fear. Additionally, stocks selection is very important, particularly following a period when owning money-losing high-flyers trading on multiples of potential sales years into the future was in fashion. The recent sell-off has not only decimated those high-flyers, but also created bargains in the shares of many high-quality companies. Although for now it is definitely (in the words of Pooh) an “oh bother” environment, sentiment will ultimately change for the better.
As a result of the volatility in the market and craziness in the world, we haven’t done any Chicago sports team updates lately. In any event, it does not seem like there is anything of note to report. The Bulls, Bears, White Sox, & Cubs all seem mired in mediocrity. Perhaps that pendulum can swing as well?
Listening for Inflation Trend Clues
Inflation trends seem to be the most significant influence on financial markets sentiment lately, and this tendency probably will persist through the rest of this earnings reporting season that winds up in mid-May. Inflation statistic trends not only can impact margins and earnings trends of companies, but also will influence Fed decision-making in the coming months. Any further acceleration in inflation statistics will intensify hawkish sentiment and pressure the bond market, while any signs of inflation peaking or slowing would likely empower the doves and encourage risk-on behaviors. As we have done for several years, we’ll be monitoring corporate comments and the economic data available for any changes in recent trends.
The consumer price index report for April on Wednesday is expected to show some moderation from the 8.5% year-over-year increase in the March report, and Thursday’s release of the producer price index is also forecasted to show some modest easing from the torrid 11.2% jump in March. Any significant surprises on the level of those gauges will certainly move the markets.
Since early March 2021, we have been very focused on inflationary pressures since early 2020, when in our 3.1.21 weekly blog we wrote “With all due respect to Chairman Powell, whom we believe is doing a fantastic job, we think that inflation is likely going to force the Fed to reconsider policy sooner than currently envisioned. . . We monitor approximately 40 macroeconomic statistical series . . . Approximately a dozen of these statistical series track Producer Price Indexes, or “PPIs,” which historically have been a useful forward indicator of retail prices because PPI measures the cost of providing goods and services, which ultimately must be paid for by end users. While these PPI statistics generally ‘wiggle upward’ over time with some of the data we track falling at times and others rising at the same time, for the first time in memory almost all of the approximately dozen PPI data series we follow rose in December and January. We don’t see this as a dire indicator regarding inflation, but rather view the data as useful to shape our views on opportunities. Specifically, a consistently inflationary economic environment is likely supportive of banking earnings growth (higher interest rates and yield spreads) and credit trends (rising nominal asset prices allow for easier repayment of existing loans).”
So far, this earnings season has driven a sharp increase in market volatility, as well as a clearly consistent message from reporting companies: passing through inflation is the current top business priority. This is why stocks have historically been a successful inflation hedge: shares outstanding generally do not change, but revenues expand, and margins expand, driving greater earnings per share. We are increasingly hearing this theme from the companies we speak with. For example:
Company 1 prior quarter comment in late January: We are already the premium priced product in the market, so we are not sure we can increase prices for our machines.
Company 1 comment this quarter in late April: We are raising prices across the board on both our products and our ongoing service contracts. When we call a customer to explain the service contract pricing, they already know why we are calling.
Company 2 prior quarter comment in late January: Our margins were hurt by temporary labor shortages associated with the Omicron Covid spike, and we had to pay a lot of overtime to those workers who were available. Customers were not on the hook for those unexpected costs, so the costs hit us dollar for dollar.
Company 2 comment this quarter in late April: What seemed like a temporary spike in labor costs due to labor shortages is continuing. We have restructured many contracts successfully to add flexibility to pass on overtime, contract labor, and other labor costs to customers in a real-time manner, rather than having to invoice and negotiate.
Company 3 prior quarter comment in late January: “We …continued to accelerate pricing to 4% as we exited the fourth quarter…”
Company 3 comment this quarter in late April: “Importantly, our team reacted aggressively and continued to accelerate our pricing, which reached 5% in the quarter, up from 3% in the fourth quarter. ”
Although inflation data and news will probably dominate the last week or so of the earnings reporting season, developments in the war and the pandemic, the two other root causes for the inflation spike (besides the extraordinarily expansive monetary policy) will also continue to be of utmost importance. We also believe that Friday’s University of Michigan Consumer Sentiment Index for May report could be significant. Economists forecast a decline of approximately 2 points from April’s reading which had showed a nice rebound to 65.1.
Stocks on the Move
+11.5% Advanced Micro Devices Inc (AMD) operates as a semiconductor company worldwide. Its products include microprocessors, chipsets, discrete and integrated GPUs, data center and professional GPUS, and development services. Last week, Advanced Micro Devices reported $1.13 per share in earnings for the first quarter with strong numbers coming from its Computing and Graphics segment. The Company also raised its full-year guidance to reflect a 60% y/y increase in revenue, versus a previous outlook of 31%.
+31.8% CarParts.com Inc (PRTS) retails automobile parts online. The Company offers mirrors, engines, headlights, brakes, interior and exterior accessories, tools, wheels, lighting, bumpers, and other aftermarket autobody parts in its network of over 1.2 million SKUs. CarParts surged last week after reporting strong Q1 results with record sales and a 280-bps expansion in gross margin. The Company remains focused on its existing strategy that includes “outstanding customer service, operational excellence, financial discipline, and innovation.”
+13.5% 1-800-Flowers.com Inc (FLWS) is an e-commerce provider of floral products and gifts. The Company’s product offerings include fresh-cut and seasonal flowers, plants, floral arrangements, home and garden merchandise, and gift baskets. There was no significant company news last week.
-13.5% Accuray Inc (ARAY) designs, develops, and sells advanced radiosurgery and radiation therapy systems for the treatment of tumors throughout the body. There was no significant company news last week.
-16.0% Denny’s Corporation (DENN) operates as a full-service family restaurant chain directly and through franchises. The Company consists of more than 1,700 franchised, licensed, and company-operated restaurants around the world. DENN slid last week after revising guidance to reflect increased cost pressures and moderate softening in consumer demand. The Company also announced the $82.5M acquisition of Keke’s Breakfast Café, a Florida-based franchise with over 50 locations. This acquisition will allow Denny’s seasoned franchisees to expand their AM eatery portfolios.
The stocks mentioned above may be holdings in our mutual funds. For more information, please visit www.nsinvestfunds.com.