More Signs of Weakening Consumers

More Signs of Weakening Consumers

Home Depot and Walmart reveal strained shoppers … more indicators suggesting consumer weakness … a “death zone” for the S&P … the S&P must hold an upcoming support level

For a lens into how the Main Street shopper is holding up, look to big box retailers.

Yesterday, we received two such earnings reports that reveal growing consumer weakness.

First, Home Depot reported earnings, missing its revenue expectation for the first time since 2019. More concerning to Wall Street was Home Depot’s outlook for the coming year.

It expects sales to be flat and earnings-per-share to post a mid-single-digit percent decline due to what CFO Richard McPhail says will be pressure in the goods sector and flat consumer spending.

Walmart was the second retailer that reported yesterday.

While it beat on both revenues and earnings, its CFO John Rainey reported that consumers are buying fewer discretionary items as grocery prices remain high.

He echoed the same muted outlook as Home Depot for the rest of the year.

From Rainey:

The consumer is still very pressured.

And if you look at economic indicators, balance sheets are running thinner and savings rates are declining relative to previous periods.

And so that’s why we take a pretty cautious outlook on the rest of the year…

There’s still a lot of trepidation and uncertainty with the economic outlook…

We’ve not been in a situation like this where the Fed is raising at the rate that it does.

Speaking of “economic indicators,” new data reveals that more Americans are falling behind on their car payments

Let’s jump to The Wall Street Journal:

…A rising number of Americans are falling behind on their car payments. 

Some 9.3% of auto loans extended to people with low credit scores were 30 or more days behind on payments at the end of last year, the highest share since 2010, according to an analysis by Moody’s Analytics.

The article points out how car prices skyrocketed during the pandemic due to shortages. Some car-buyers took out loans to pay higher prices. Now, as inflation continues to eat away at family budgets, the households that were on the financial ledge are losing ground.

As of today, the number of defaults remains below pandemic levels. But as the economy continues to soften under the weight of rate-hikes, that could change.

Back to the WSJ:

Stress in the auto-loan market is concentrated among borrowers with credit scores below 660 and is especially high among people with bottom of the barrel credit. But the stress could spread if the U.S. goes into a recession, as many economists expect.

If job losses increase, many more consumers might find themselves unable to keep up with the record amounts of debt they took out in recent years.

Last week, the CEO of NerdWallet Tim Chen commented on this weakness in lower-credit-score Americans, saying “the state of the consumer feels like a tale of two cities.”

From Chen:

We’re seeing continued strength relative to historical norms in the prime and super-prime segments and definitely some credit deterioration in the near-prime and subprime space.

This comes as credit card debt (which is often used by subprime shoppers) reached a record high by of the end of 2022. The Federal Reserve Bank of New York found that credit card balances increased $61 billion in the fourth quarter to $986 billion, eclipsing the pre-pandemic high of $927 billion.

Plus, as we noted in the Digest last week, the annual percentage yields on credit cards are exploding. LendingTree reports that the average credit card interest rate today is an eye-watering 23.55%.

Clearly, record credit card debt at record credit card interest rates is not good for consumers.

So, combine muted outlooks from big box retailers, signs of growing weakness in the U.S. shopper, and rising consumer debt, and it’s only maintained our months-long cautious outlook here in the Digest.

Is Wall Street beginning to embrace the same caution?

As you know, January brought a blistering stock market rally. In fact, it registered as the fifth best opening to a year in 100 years.

But stocks have run into turbulence here in February. Last week in the Digest, we questioned whether January was a bear-market rally and February’s weakness is the beginning of a new leg down…

Or if January’s strength was the beginning of a new bull market, and February’s weakness is simply healthy consolidation.

Strategist Mike Wilson at Morgan Stanley believes it’s the former.

He just compared the recent stock market run up to the Jon Krakauer’s best-seller “Into Thin Air,” that tells the story of the death of 12 mountaineers scaling Mount Everest.

From Wilson:

Either by choice or out of necessity investors have followed stock prices to dizzying heights once again as liquidity (bottled oxygen) allows them to climb into a region where they know they shouldn’t go and cannot live very long.

They climb in pursuit of the ultimate topping out of greed, assuming they will be able to descend without catastrophic consequences.

But the oxygen eventually runs out and those who ignore the risks get hurt.

Wilson starts by pointing toward the beginning of the rally back in October when fundamentals were in better shape

The S&Ps price-to-earnings (PE) ratio was 15 and the equity risk premium was 270 basis points.

(The equity risk premium is the spread between the expected earnings yield and the yield on Treasury bonds. A higher number means investors are being compensated more for stock investments).

But as the rally moved into December, the market’s PE ratio shot up to 18 and the equity risk premium slumped to 225 basis points.

And then came the market explosion in January.

Here’s MarketWatch, continuing with Wilson and his Everest analogy:

But then 2023 started, and “the surviving climbers decided to make another summit attempt, this time taking an even more dangerous route with the most speculative stocks leading the way,” on the faulty premise of a Fed rate-hike pause, to be followed by cuts later in the year.

“Investors began to move faster and more energetically, talking more confidently about a soft landing for the U.S. economy. As they have reached even higher levels, there is now talk of a ‘no landing’ scenario – whatever that means. Such are the tricks the death zone plays on the mind – one starts to see and believe in things that don’t exist,” says Wilson.

Here’s Wilson’s “Death Zone” chart showing the S&P’s collapsing equity risk premium.

Source: Morgan Stanley

Wilson’s concern, which we share here in the Digest, is that January’s bullishness has sprung from hopes of Fed dovishness that won’t materialize.

Yes, the Fed will pause its rate-hikes sometime this year. But everything we’re hearing from the Fed suggests rates will remain at their eventual terminal rate (above 5%) into next year.

That degree of tightness will continue to weigh on the economy and corporate earnings, setting the stage for a major inconsistency if Wall Street bulls continue to bid up prices.

From MarketWatch:

Back to Wilson, who says the P-to-E ratio is now 18.6, and equity risk premium at 155 basis points, meaning “we are in the thinnest air of the entire liquidity-driven secular bull market that began back in 2009.”

He says the bear market rally that begin in October from reasonable prices has turned into a speculative frenzy based on a Fed pause/pivot that isn’t coming.

Keep your eye on this level

In January, the S&P finally broke through its down-sloping trend line, something it hadn’t been able to do in all of 2022.

But as February’s weakness as continued, the S&P has fallen and is now approaching this down-sloping trend line.

As you can see below, the trend-line continuation level is roughly 3,925.

Chart of the S&P showing its down-sloping trendline and the S&P falling back down toward this trendline


That’s only about 1.5% below us as I write Wednesday morning.

I should point out that the S&P’s 200-day moving average comes in at roughly 3,940, adding even more importance to this general level.

How the S&P handles this 3,925 – 3,940 range will be incredibly important. If we bounce, it suggests the bulls have more strength and January’s rally might have longer legs.

But if the S&P falls through this range and can’t rally above it, watch out. That would suggest that January was, in fact, a bear-market rally and there’s more weakness on the way.

We’ll keep you updated.

Have a good evening,

Jeff Remsburg

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