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Weekly Issue: While far from booming, U.S. economy not as bad as the headlines

Weekly Issue: While far from booming, U.S. economy not as bad as the headlines

Key points inside this issue

  • Thematic confirmation in the July Retail Sales report
  • Getting back to the global economy and that yield curve inversion
  • The week ahead
  • The Thematic Leaders and Select List
  • A painful reminder about dividend cuts

Despite Friday’s rebound, the stock market finished down week over week as it continued to grapple with the one-two punches of the slowing global economy and U.S.- China trade. There was much chatter on the recent yield-curve inversion, but as we look back at the economic data released last week, the U.S. economy continues to be on more solid footing than the Eurozone or China.

That’s not to say the domestic economy is booming. The Cass Freight Index, weekly railcar-traffic and truck-tonnage data and the July U.S. industrial-production report’s manufacturing component leave little question that America’s manufacturing economy is slowing. And as we saw last week, the U.S. consumer buoyed the economy in July with stronger-than-expected retail sales.


Thematic confirmation in the July Retail Sales report 

Last week’s July Retail Sales Report confirmed one of the key aspects of our Digital Lifestyle investment theme – the accelerating shift toward digital shopping that continues to vex brick and mortar retailers, particularly department stores. Granted, the year over year increase in non- store retail sales of 16.0%, which was several magnitudes greater than overall July Retail Sales that rose 3.4% year over year and bested sequential expectations, was aided by Thematic King Amazon’s (AMZN) 2019 Prime Day event but one month does not make a quarter. For the three months ending July, non-store retail sales rose 14.2% year over year, easily outstripping the 3.2% year over year comparison for overall retail sales. 

Clearly, the shift to digital shopping is not only underfoot, or more properly stated on a variety of keyboards, it is accelerating, and the victims continue to be department stores, electronics and appliance stores, sporting goods and bookstores, and to a lesser extent clothing and furniture. We’re seeing this play out in the results from Macy’s (M) as well as J.C. Penney (JCP), which is so strategically lost it is venturing into the used clothing market through a partnership with online consignment company thredUP. With its July quarter sales down 9% year over year, J.C. Penney is going for the “Hail Mary” pass with this move, but it’s only going to bring cheaper product in to compete with its already low-priced offering. I can almost understand the J.C. Penney is looking to double-down on our Middle-Class Squeeze investing theme, but it’s facing stiff competition from companies like Poshmark that are doing that as well as riding our Digital Lifestyle theme. 

Each of those challenged categories I mentioned above are also areas that Amazon continues to target with offerings from both third-party sellers as well as its growing private label line of products. I’ve often said Amazon shares are ones to hold, not trade, and we continue to feel that way as we approach the seasonally strongest time of the year for its business.


Getting back to the global economy and that yield curve inversion

For now, the U.S. economy remains the best house on the economic block — but it’s showing signs of wear. Of course, the fact the yield curve inverted briefly last week rang the “Recession Warning Bell.” But let’s remember that there’s historically been a lag of up to almost two years following that warning. Moreover, the Federal Reserve has already adopted a more dovish tone and will likely stand ready to add more stimulus to the economy if need be. All eyes will now on the Fed’s mid-September monetary-policy meeting.

Meanwhile, as economic-growth worries increased in the Eurozone and China last week, we heard about a big bazooka of stimulative measures that the European Central Bank is considering for its Sept. 12 policy meeting. China will also reportedly soon roll out a plan to boost disposable income over the coming quarters to spur its domestic consumption.

I would suggest you tune in later this week for what Tematica’s Chief Macro Strategist Lenore Hawkins has to say on this.

We’ll continue to monitor how global central bankers try to steer their respective economies in the coming weeks. While we suspect that Wall Street will likely cheer any and all dovish moves, the question remains how stimulative those policies will really be if the U.S.-China trade war continues.

U.S.-Chinese trade talks are set to resume in September, which tells us that we might get a lull in Wall Street’s recent volatility. But we should by no means think that “Elvis has left the building,” and we could very well see another round of turbulence in the coming weeks.


The Week Ahead

With two weeks to go until the Labor Day holiday weekend, we’re officially in the dog days of summer. These weeks historically see lower-than-usual trading volume, as investors and traders look to squeeze in that last bit of fun in the sun. Following last week’s full plate of economic data, this week will have a far smaller helping coming at us. Upcoming reports include July new- and existing-home sales, as well as the Index of Leading Economic Indicators.

Investors will also focus on what the latest flash PMI data from IHS Markit has to say about the global economy when that report lands on Aug. 22. I’ll be looking to see whether the U.S. economy continues to outperform Japan, China and the Eurozone following data out last week that suggested the German and Chinese economies continue to slow.

Reading those reports and the upcoming Federal Open Market Committee meeting minutes should set the stage for what we’re likely to hear when the FOMC next meets on Sept. 18. We’ll also have more data coming our way over the weeks leading up to the FOMC session, and we’re apt to get a few surprises along the way. While there’s no Fed interest-rate meeting scheduled for August, the Kansas City Fed will hold its widely watched annual Jackson Hole symposium Aug. 22-24 in Wyoming. The central bank doesn’t usually discuss monetary-policy plans at this event, but we aren’t exactly in normal times these days.

On the earnings calendar this week, the focus will continue to be on retail. If we were reminded of one thing last week in retail land, it’s that not all companies are responding the same way to retailing’s changing landscape. Just look at what we heard last week from Walmart (WMT), Macy’s (M) and JCPenney (JCP). Other key retail reports to watch this week include Home Depot (HD), Kohl’s (KSS), Lowe’s (LOW), Target (TGT), Dick’s Sporting Goods (DKS), and Foot Locker (FL). I’ll be looking for the degree to which they’re embracing digital shopping, as well as what they have to say about tariff implications and their expectations for 2019’s remainder.

We’ll also hear from Salesforce (CRM) and Toll Brothers (TOL), which should shed some light on the housing market and IT spending associated with our Disruptive Innovators and Digital Infrastructure investing themes.


The Thematic Leaders and Select List

As I noted above, last week was another choppy one for the stock market and those swings stopped out of Thematic Digital Infrastructure Leader Dycom Industries (DY) as well as Cleaner Living company International Flavors & Fragrances (IFF) shares. Given that we were stopped out, it means we took some losses in those two positions, but as I look at the live ones across the Thematic Leaders and the Select List I see an impressive array of returns with our Amazon, Costco Wholesale (COST), Chipotle Mexican Grill (CMG), McCormick & Co. (MKC), Walt Disney (DIS), Universal Display (OLED) and USA Technologies (USAT) shares. 

Wide swings in the market can present both challenging times as well as opportunities provided, we get some degree of clarity. As I touched on above, the first few weeks of September could be when we see that clarity emerge. Until then, we’ll continue to look for thematically well positioned companies at favorable risk to reward entry points. 


A painful reminder about dividend cuts

Last week I mentioned that the following – I’m focusing more on domestic-focused, inelastic business models that tend to spit off cash and drive dividends. In particular, I’m looking at companies with a track record of increasing their dividends every year for at least 10 years. And of course, they have to have vibrant thematic tailwinds at their respective back.

While I was doing just that, shares of famous lawn-mower engine maker Briggs & Stratton Corp. (BGG) — whose shares tumbled 44.5% last Thursday — presented a sharp reminder as to what can happen when a company cuts its dividend. Yes, the shares rebounded late last week along with the market, but they’ve been generally falling for a long time as the company’s dividend looked shakier and shakier.

Investors tend to think of quarterly dividends as payments in perpetuity, but these payouts are actually only declared at a company board’s discretion. When dividends are disrupted, that can lead to significant share-price pain for a stock.

In this case, Briggs & Stratton not only cut its dividend and reported a far-greater-than-expected quarterly loss, but also slashed its outlook for the balance of the year. The company now expects to earn just $0.20-$0.40 per share for the full year, which down significantly from its prior forecast of $1.30.

When matched up against its revised revenue forecast of $1.91 billion to $1.97 billion vs. a prior $2.01 billion, it’s rather evident that BGG’s cost structure has become an issue. So, it’s no little surprise that Briggs & Stratton also announced plans to close a plant that manufactures engines for the walk-behind lawn mowers you commonly find at Home Depot (HD) or Lowe’s (LOW) .

The company called out that product category in particular for weakness, which management attributed to the U.S. housing market’s current tone. I’ve previously talked about how new- and existing-home sales have been rather sluggish despite the recent mortgage-rate drop, with low rates fueling a wave of home refinancings rather than purchases.

But the biggest factor behind Thursday’s steep BGG dive was the fact that management slashed the company’s quarterly dividend by 64% to $0.05 per share from the prior $0.14. That one-two-three punch combination — bad earnings, a bad forecast and a dividend cut — sent Briggs & Stratton’s share price tumbling.

Going into Thursday morning’s earnings report, BGG shares were sporting a 6.8% dividend yield, which is on the lofty side. Investors should have interpreted that as a warning and here’s why – even before Thursday’s selloff, BGG shares had been down some 70% since January 2018, partly because the company missed analysts’ earnings expectations for the prior three quarters. In hindsight, the misses were escalating in percentage terms — a trend that continued with Thursday’s earnings report.

Paired with the dividend cut, there’s little confidence any more in the current management team, which means BGG shares are likely to flounder further due to several unknowns. Some of those unknowns are company specific, like: “Will be the plant closure deliver sufficient savings?” But others are about the U.S. economy’s future vector and velocity, which Thursday’s July industrial-production report shows is continuing to cool.

And while the July U.S. retail-sales report came in better than expected, we already know that consumers aren’t buying lawnmowers. And unfortunately, that’s not likely to change any time soon as we put the summer behind us.

The bottom line — as I’ve discussed before, when a stock’s dividend yield looks too good to be true, odds are it is just that. BGG is just the latest stock to prove that. While its newly revised dividend yield (4.1%) might still look enticing, it’s not one that we should be clamoring for given the lack of thematic tailwinds for its lawnmowing business. But at a minimum, no investor should consider the shares until there is some proof that management’s turnaround plan is on the cusp of delivering. 

Weekly Issue: Trade and geopolitical issues make for a less than sleepy August 2019

Weekly Issue: Trade and geopolitical issues make for a less than sleepy August 2019

Key points inside this issue

  • Trade and geopolitical issues make for a less than sleepy August 2019
  • What to watch this week
  • Earnings this week
  • Economic data this week
  • The Thematic Aristocrats?

Uncertainty continued to grip the stock market last week as the U.S.-Chinese trade dispute once again took center stage. After the return of tariff talk week prior, the battle expanded this week to include a war of words between Washington and Beijing over the Chinese yuan’s devaluation.

The market ultimately shook that off, in part due to the renewed thought that the Federal Reserve could accelerate interest-rate cuts. But then stocks closed lower week over week after President Trump suggested Friday that trade talks with China set for next week might be canceled.

There’s also renewed geopolitical uncertainty — not just Britain’s Brexit process, but also a looming no-confidence vote against Italian Prime Minister Giuseppe Conte that’s once again plunging Italy into political turmoil. And as if that wasn’t enough, over the weekend escalating tensions between Chinese authorities and protesters in Hong Kong were added to the mix, making for one big ball of uncertainty even bigger.

Meanwhile, global economic data continue to soften. This gives some credence to the notion that the Fed could become more dovish than Chairman Jerome Powell suggested during his July 31 press conference following the Federal Open Market Committee’s decision to cut rates. While I don’t expect anything near-term, down below we have a calendar date to mark even though I don’t think it will mean much in the way of monetary policy.

We’re seeing confirming signs for the economic data in oil and copper prices, both of which have been mostly declining of late. Not exactly signs of a vibrant and growing global economy.

Odds are that as we head into summer’s final weeks, stocks will be range-bound at best as they trade based on the latest geopolitical headlines. And odds are there won’t’ be any newfound hope to be had on the earnings front. With 90% of S&P 500 stocks already reporting second-quarter results, it looks like we’ll see another year-over-year decline in quarterly average earnings. For the full year 2019 those earnings are only growing at a 2.5% annual rate, but if President Trump goes forth with the latest round of announced tariffs, odds are those expectations could come down in the coming weeks – more on that below.

All in all, barring any meaningful progress on US-China trade, which seems rather unlikely in the near-term, at best the stock market is likely to be rangebound in the coming weeks. Even though much of Wall Street will be “at the beach” the next few weeks, odds are few will be enjoying their time away given the pins and needles discussed above and further below.

What to watch this week

We have three weeks until the Labor Day holiday weekend, which means we’re entering one of the market’s historically slowest times. There’s typically lower volume than usual, as well as low conviction and wishy-washy moves in the market.

Traditionally, a more-sobering look emerges once Wall Street is “back from the beach” following the Labor Day holiday. This tends to bring a sharper picture of the economy. There are also ample investor conferences where companies update their outlooks as we head into the year’s last few months.

But as we saw this past week, geopolitical and trade tensions could make the next few weeks much more volatile than we’ve seen in the past. As we navigate these waters, we’ll continue to assess what this means for earnings — particularly given that analysts don’t expect the S&P 500 companies to see year-over-year earnings-per- share growth again until the fourth quarter. In my view that puts a lot of hope on a seasonally strong quarter that could very well be dashed by President Trump’s potential next round of tariffs. I say this because retailers now face the 10% tariffs set to go into effect on September 1, which will hit apparel and footwear, among other consumer goods.

The risk is we could very well see 2019 turn into a year with little to no EPS growth for the S&P 500, and if factor out the impact of buybacks it likely means operating profit growth had at the S&P 500 is contracting year over year. We’ll know more on that in the coming weeks, but if it turns out to be the case I suspect it will lead many an investor to question the current market multiple of 17.6x let alone those market forecasters, like the ones at Goldman Sachs, that are calling for 3,100 even as their economists cut their GDP expectations.

Earnings this week

This week will have the slowest pace of earnings releases in about a month, with only some 330 companies issuing quarterly results. That’s a sharp drop from roughly 1,200 such reports that we got last week.

Among those firms reporting numbers next week, we’ll see a sector shift toward retail stocks, including Macy’s (M), J.C. Penney (JCP) and Walmart (WMT). Given what I touched on above, I’ll be listening for their comments on the potential tariff impact as well as comments surrounding our Digital Lifestyle and Middle-class Squeeze investing themes, and initial holiday shopping expectations.

This week’s earnings reports also bring the latest from Cisco Systems (CSCO), Nvidia (NVDA), and Deere (DE). Given how much of Deere’s customer base sells commodities like U.S. soybeans (which China has hit with tariffs), we’ll carefully listen to management’s comments on the trade war. There could be some tidbits for our New Global Middle-class theme from Deere as well. With Cisco, we could hear about the demand impact being generated by 5G network buildouts as well as the incremental cyber security needs that will be needed. These make the Cisco earnings conference call one to listen to for our Digital Infrastructure and Safety & Security investing themes.

 

Economic data this week

On the economic front, we’ll get July reports for retail sales, industrial production and housing starts, as well as the August Empire Manufacturing and Philly Fed surveys. Given the importance of the consumer, the July Retail Sales will be one to watch and I for one expect it to be very bullish for our Digital Lifestyle investing theme if and only if because of Amazon’ 2019 Prime Day and all the other retailers that tried to cash in on it. I suspect, however, the report will reveal more gloom for department stores. All in all the week’s economic data points will help solidify the current quarter’s gross domestic product expectations, which are sitting at 1.6%-1.9% between the New York and Atlanta Fed.

Based on what we’ve seen of late from IHS Markit for Japan, China and the Eurozone, that still makes America the best economic house on the block. Granted, the U.S. vector and velocity are still in the down and slowing positions, but we have yet to see formal signs of a contracting domestic economy. As Tematica’s Chief Macro Strategist Lenore Hawkins pointed out in her most recent assessment of things, we’ll need to keep tabs on the dollar for “The deflationary power of a strengthening US dollar strength in the midst of slowing global trade and trade wars just may overpower anything central banks try.”

Odds are that as the latest economic figures hit, especially if they keep the economy’s recent vector and velocity intact, we will see more speculation on what the Fed might do next. While there’s no Fed interest-rate meeting scheduled for August, the Kansas City Fed will hold its widely watched annual Jackson Hole symposium Aug. 22-24 in Wyoming. The central bank doesn’t usually discuss monetary-policy plans at this event, but as noted above, we aren’t exactly in normal times these days.

 

The Thematic Aristocrats?

Given the recent market turbulence as prospects for more of the same in the coming weeks, I’m sitting back and building our shopping list for thematically well-positioned companies. Given the economic data of late and geo-political uncertainties as well as Lenore’s comments on the dollar, I’m focusing more on domestic-focused, inelastic business models that tend to spit off cash and drive dividends. In particular, I’m looking at companies with a track record of increasing their dividends every year for at least 10 years. And of course, they have to have vibrant thematic tailwinds at their respective back.

Perhaps, we can informally call these the “Thematic Aristocrats”?

I’ll have more as I refine that list.