May 20th, 2022
Markets posted their eighth consecutive negative return this week, making this the longest losing streak for the S&P 500 and NASDAQ since 2001 and since 1932 for the Dow Jones Industrial Average. Bulls and bears spent the week skirmishing around the -20% decline mark (from previous highs), which would signify an official bear market. While the significance of a -20% decline is somewhat arbitrary from a fundamental standpoint, the figure holds a certain lore that, once broken, risks bringing additional technical factors into play that could amplify volatility near term. Notable earnings misses from retail giants Walmart and Target were this week’s primary catalyst. The two retailers’ reports highlighted the challenges they are facing from higher goods and transportation costs and a rapid shift in consumer spending habits that has forced retailers to absorb lower margins in order to prevent losing market share. While April’s retail sales report showed that the consumer continues to spend at a healthy clip, consumers are being forced to shop “smart” in order to preserve their budgets in the midst of persistent inflation, supply chain constraints, market volatility and global unrest, according to the National Retail Federation. These observations along with lower home unit purchases, increasing (but not yet high) subprime defaults for auto loans and credit cards, rising credit balances, and falling savings rates (but not yet low) all raised alarms this week over whether the lower-and middle-class consumer is beginning to run out of steam. Markets were jolted by the week’s announcements which resulted in the S&P 500 declining -3.05% to close at 3,901.36 – just above a bear market.
Consumer Spending Shifts from Goods to Services
The long-anticipated shift in spending from goods to services appears to now be underway. In April, retail sales rose a healthy 0.90% to $677.7 billion. The increase follows March’s upwardly revised 1.40% gain, up from the prior 0.50% print. April’s gains were led by a 4.00% rise in miscellaneous store sales. The sector includes florists, stationery, and gift stores. The rise suggests consumers are putting more activities on their social calendars and are in need of gifts and party decorations. Restaurants and bars also attracted the party and after-party crowd, posting a 2.00% increase in sales. The consumption shift was notable in earnings reports from Walmart and Target. The two retail giants’ results rattled markets as the retailers appeared to be caught entirely flatfooted by the rapid shift in consumer spending and the impact rising prices would have on their margins, causing both companies to miss their earnings estimates. At Walmart, the grocery business took the impact as rising food prices forced customers to trade down from brand-name products to less expensive private label products in order to stretch their dollars. Meanwhile, Target missed their earnings projections, observing that consumers were increasingly socializing and getting ready for the upcoming travel season instead of ordering online or shopping in stores. The retailer saw luggage sales increase a robust 50%+ in the quarter. However, that increase wasn’t enough to make up for waning demand for goods such as tv’s and kitchen appliances. Notably, Target’s CEO stated that the company had decided to absorb higher costs by lowering the company’s profit margins, rather than pass inflation along to consumers for fear of losing market share to competitors longer term. That comment sent shockwaves across the entire retail sector over concerns that the consumer is beginning to struggle and earnings are likely to suffer in the near term as a result.
With median home prices rising 14.80% year-over-year to a record high of $391,200, homebuyers hit pause on purchasing a home in April. Existing home sales slipped -2.40% in April to a seasonally adjusted annualized rate of 5.61 million units. Year-over-year, sales slipped -5.90%, the slowest pace since the Covid pandemic started. The overall sales decline was driven by a -29% drop in sales of homes priced between $100,000 and $250,000, which reinforces the notion that the mass market is struggling with everyday inflation and rising interest rates curtailing affordability. The average rate for a 30-year fixed-rate mortgage rate is now 5.50%. That’s roughly 2.00% above December 2021’s level, which is resulting in reduced demand for mortgages. Mortgage applications for homes were down -12% week-over-week and down -15% yoy. The decline in the lower-end home sales volume offset a 16% increase in sales of homes priced over $1 million. Despite, the yoy comps looking poor, keep in mind that they are being compared to a previous inflated period. It is still an unquestionably strong housing market, and sellers are not eager to negotiate on price or to add supply. Only 1.03 million homes were available for sale in April. That represents a 2.2-month supply. By comparison, six to seven months is considered to be a healthy balance between supply and demand. Rising rates may have already started to cool demand somewhat, but until inventory starts to increase, pricing is likely to remain elevated and keep would-be buyers on the sidelines.
Eight consecutive, weekly losses are enough to test anyone’s mettle. After each one, we have continued to iterate on the facts at hand and the market’s reaction, weighing the consensus view versus our own. This week the overwhelming reaction was from Walmart and Target’s earnings reports, with investors’ sentiment following those reports being that the consumer is wearing out and the risk of a recession is rising. Yes, the consumer is cooling off on goods purchases. That may be bad for retailers–after an absurdly good COVID induced spending party–but spending is now shifting to services and experiences. On net, spending is still up, and while that is bad for Target and Walmart and retailers in general, spending is still increasing and is being spread to a part of the economy that is woefully in need. To cool inflation, unfortunately means that consumers need to spend less–particularly on hard items–and that now appears to be starting. The health of the consumer is going to appear to be deteriorating if for no other reason than the health of the consumer, in aggregate, was so greatly enhanced by the nature of the pandemic and the stimulus response relative to pre-pandemic levels. Savings rates skyrocketed during the pandemic. Oddly, subprime default rates also fell. Those trends are now reversing, and while this is something that needs to be watched, they presently appear to be moving towards pre-pandemic levels and not yet below. Q2 still appears to be on track for positive GDP growth. According to the latest estimate from the Atlanta Fed’s GDPNow, Q2 2022 GDP is expected to rise 2.40%. That would be a healthy rebound from Q1’s -1.40% drop, but this does not change the fact that a recession is still possible if not probable. It is just more likely a 2023 event if it happens, which raises the question of to what degree a recession is already priced in. Markets correct and sometimes enter bear territory without a recession and, to some degree, the concern material to our clients is not the recession, but the decline in portfolio value. Here is where there is reason for some optimism. Since 1975, there have been 24 instances where markets have declined more than 10%. In six of these instances (1975, 1980, 1991, 2001, 2008, 2020), we had a recession. Three of those were cataclysmic outlier events (Dot.com bust, Financial Crisis and Pandemic). Of the three remaining, only 1980 resulted in a loss greater than -20%, declining approximately -26%. There are no guarantees in life, but with the market continuing to battle around the bear market line, today’s valuation increasingly looks as if a normal, run-of-the-mill recession is already priced in.
The Week Ahead
Traders are poised to call it an early week as the Memorial Day weekend is upon us. Week in Review will be packing it up for the holiday weekend as well. Our next edition arrives June 3rd with big reports on U.S. payrolls and ISM manufacturing and services. In overseas news, China releases PMI numbers.
2,000 Year Old Statue Found in Texas Thrift Store
Earlier this month, a 2,000 year old Roman statue went on display at the San Antonio Museum of Art. The ancient bust was found in a thrift store by a woman in Austin, Texas who purchased it for less than $40.
The statue is from around the first century BC or first century AD. Laura Young, an art collector, was shopping at a Goodwill Store when she spotted a sculpture on the floor underneath a table. She bought the piece for $34.99 and then buckled the bust into the back seat of her car and took it home. She believed it to be very old and began doing research to figure out its origins. In the process, Young reached out to art history experts at the University of Texas at Austin and to experts at art auction houses across the country to solve the mystery.
These experts helped piece together the statue’s backstory. Young learned that statue was once part of the collection of King Ludwig I of Bavaria, who lived from 1786 to 1868. King Ludwig, an avid collector of Italian art and antiques, was inspired by the excavations of Pompeii that took place during his lifetime. He built a full-scale replica of a villa from Pompeii in Aschaffenburg, Germany, naming it the Pompejanum. The bust had last been catalogued in the 1830s as part of Ludwig’s collection. During World War II, the museum was severely damaged with much of the art inside having been destroyed or looted. The piece in Young’s possession hadn’t been included in any official records since that time. A restoration of the Pompejanum began in 1960, and it re-opened 1994, but the location of the bust remained unknown until Young’s discovery.
Young also learned that the bust is believed to be a depiction of either a son of Pompey the Great who was defeated in civil war by Julius Caesar or a depiction of Roman general Drusus Germanicus.
No one is quite sure of how the bust went from being nearly destroyed in Germany to a thrift store in Austin, but the team Laura consulted noted that the U.S. Army established a base in Aschaffenburg, so a soldier likely either looted or purchased the 52-pound statue before bringing it to the U.S. It is speculated that the bust must have ended up in someone’s house and sat there for decades before being donated to Goodwill, where a $34.99 price tag was stuck to its marble cheek.
When Young realized she was in possession of stolen property, she retained a lawyer to determine ownership and help her return the bust to Germany. Young and her attorney were able to reach an agreement with the Bavarian Administration of State-Owned Palaces, Gardens, and Lakes to have the bust on display at the San Antonio Museum of Art until its permanent return to Germany in May 2023.
The exact terms of the deal that Young worked out with German authorities are confidential, but Young did receive a finder’s fee. You can read more about this fantastic story on the San Antonio Museum of Art’s website and see a picture of the thrifted piece of Roman and German history that now has ties to Texas.