Heading into the week, consumer discretionary was the sector with the lowest percentage of firms reporting. With just above half of them reporting earnings as of May 4th, this week promised to be chock full of retail reports. The chart below shows how the retail earnings situation looked coming into the week.
Most sub-industries showed signs of weakness. There are a few trends worth pointing out.
The first trend is towards growth in home improvement. Even though online retail is taking share from physical locations, buying heavy products and live plants still is better to do at the store. Shipping heavy goods to your house such as rocks for your backyard isn’t efficient. Another mega trend is food distributors taking share in malls away from apparel stores. Restaurants in malls take out longer leases.
They are also forces that are making retail more resistant to losing market share to online. For instance, automotive retail is growing because it’s powered by an alarming increase in auto loans. Although car sales have declined in the past 4 months, the record sales from last year are still powering retail growth. However, online retail is killing general merchandising stores as buying goods online on a mobile device is very convenient.
Disastrous retail earnings reports sent the apparel names cratering lower. Nordstrom’s reported same store sales which were down 0.8% which missed estimates for a 0.1% decline. The stock fell 17.62% in the last 3 days of the week. Macy’s saw a 4.6% decline in same store sales which missed estimates for a 2.7% decline. Macy’s stock fell 19.53% since Wednesday. JC Penny’s was the biggest loser of the group as its same store sales fell 3.5% missing expectations for a 0.6% drop. The stock fell 20.32% since Wednesday to its lowest price since 1974.
The takeaway from these earnings reports is that Amazon is dominating department stores.
Here is the long-term trend of what’s happening:
This means department stores will be closing quickly in the next 12 months as these firms try to cut costs and expand their online presence. Malls will focus more on hosting events as well as restaurants.
Are Investors Complacent?
The VIX is the volatility index, an indication of fear or perceived risk. It acts inversely to the S&P 500. When the S&P 500 goes up or barley moves, the VIX usually falls. With the stock market near its all-time high, the VIX has been falling a lot lately. It has fallen so low, new records are being broken. As you can see from the chart below, the VIX has closed below 11 for 15 straight days which is the longest streak ever. The streak is 50% higher than the prior record and it’s not over yet.
While this is great for stocks in the meantime, and while the VIX could technically continue to go lower, expectations for the future are priced for perfection. Meaning, a lot has to happen in the form of fiscal reform, which has already been accounted for by markets, which is yet to occur as we have detailed here and here. Since nothing moves indefinetly in any one direction, the liklihood that VIX will be moving higher is increasing, as it trends lower for now. Two potential catalysts for volatility are the May 25th OPEC meeting where the oil ministers decide whether to extend or end production cuts and the June 14th Fed meeting which has a 78.5% chance of seeing a 25 basis point hike in the fed funds rate.
Great S&P Earnings
The stock market rally is being fueled by great earnings reports. Even though the retailers discussed previously did poorly, almost every other sector showed dramatic improvements. As of May 4th, the trailing 12 month earnings for the S&P 500 including Q1, which is almost finished, were $100.92. This represents a 16.75% growth in trailing 12 month earnings from last year. The earnings growth is being driven by margin improvements. The Q1 profit margins are expected to be 10.06% which is up from 8.75% last year.
Profit margin expansion is being driven by the big technology firms which have natural monopolies. Examples of these monopolies are Google controlling search and Apple controlling smartphones. Although Apple, doesn’t have a majority market share in terms of shipments, it dominates the share of profits earned on the sale of the devices. The risk to this trend is that margins historically mean revert. Since margins are high now, that means they are likely to fall in the future, as opposed to rising indefinetly. Technology is the most easily disrupted sector in the world, making it difficult for these tech giants to maintain their high margins throughout the cycle.
Macron Wins In France
Last Sunday Macron beat Le Pen in the French Presidential election. This huge victory by about 30 points was a positive for European equities because Macron is seen to be more moderate than Le Pen. Macron supports the European Union while Le Pen wants to dismantle it which would have caused near-term volatility on a larger scale than the Brexit. If France leaves the EU, the entire organization would collapse as it was the originator of the pact.
The inflows into Europe were massive after this victory. The best comparison is the inflows into the American stock market after President Trump won. As you can see from the chart below, there was $6 billion in weekly fund flows into the EU equities market which is a new record.
As you can see, the exact opposite response happened after the Brexit. If Le Pen would have won, much more outflows than Brexit would have occurred as Le Pen wanted to leave the EU. The next political election for France is on June 11th and June 18th where the country will pick a new legislature. This will determine if Macron will be able to pass economic reforms or if he will face gridlock.
Earnings season is over so the market moving headlines will come from the economic reports. The calendar below shows all the economic reports which are being released next week.
The ones to focus the most on are the Empire State Manufacturing Survey, the Housing Starts, the EIA Petroleum Status Report, The Philly Fed Business Outlook Survey, and the Leading Indicators report. Besides these economic reports, two Fed officials will be speaking.
The President of the Cleveland Fed, Loretta Mester is speaking on Thursday and Bill Dudley, the President of the New York Fed is speaking on Friday. Their statements on whether the Fed will hike rates on June 14th will move the stock and bond markets. Currently there’s a 78.5% chance of a 25-basis point rate hike. The Fed has guidance for one more hike after that in 2017.