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Worries about U.S. economic growth--see those emails from Wal-Mart--couldn't be coming at a worse time for stocks
02/22/2013 8:30 am EST
Bloomberg’s publication of emails from Wal-Mart’s (WMT) vice-president of finance and logistics won’t bring down a President, but they were certainly enough to rattle the stock market on February 15.
And I think those comments continue to hang over stocks and explain a good part of recent weakness and volatility. Especially since they’ve been echoed in the company’s fourth quarter earnings results released on February 21.
In fact, I think the issue represented by these emails is the single scariest thing hanging over the stock market right now.
Emails from Wal-Mart? Scarier than the Federal Reserve minutes casting doubt on the U.S. central bank’s commitment to bond buying? Scarier than the currency wars launched by Japan that have now spread to the pound? Scarier than economic numbers that show the EuroZone sinking into recession? Scarier than the bloated balance sheets of the Federal Reserve or the off-balance sheet debt of China’s banks?
Well, in the long run—say the next year or two—absolutely not. The issues that I’ve noted above are the ones that could sink national and global economies in that time frame.
But in the shorter term—say the next few weeks or couple of months? Absolutely. Especially for U.S. stocks. Right now, with U.S. stock market indexes near five-year or all time highs, markets are poised between a consolidation that builds a base for a run higher and a correction that could take stocks down 7% to 10% in a replay of the spring and fall 2012 corrections of that dimension.
Why could news from Wal-Mart be that important in the short-run? Because some very big short-term worries could all line up in the next few weeks. Wal-Mart is just one part of that pattern. Let me explain.
In case you’ve forgotten here’s the really explosive quote from the emails published by Bloomberg: “February sales are a total disaster.” The Wal-Mart vice-president went on to say that this had been the worst start to a month he’s seen in his seven years with the company.
The worry here—and the reason that investors and traders took these comments as something more than just Wal-Mart specific bad news—is that the February crash in Wal-Mart sales was an indicator of damage done to the U.S. economy by the end of the year fiscal cliff chaos and the eventual deal that ended that crisis. That deal, if you’ll remember included the expiration of a 2-percentage point cut in FICA, the Social Security payroll tax. In order to stimulate the U.S. economy Washington had cut the Social Security tax to 4.2% from 6.2%. That put extra money into the pockets of every taxpayer but most emphatically into the pockets of lower income families. After the deal, the worry was that ending this tax cut would immediately lower spending by these families and end it immediately since the end of the tax cut would result in a reduction in take home pay not next month or next quarter, but this week.
Wal-Mart’s bad sales in early February seemed to confirm the reality of these fears. (It didn’t help either that because of the chaos of the fiscal cliff crisis the IRS had delayed processing of early tax returns. A significant portion of Wal-Mart shoppers files early and then uses an early refund or a tax-refund check from a tax preparer such as H&R Block to make a major purchase or two in the early part of the year.)
The Wal-Mart news hit the stock market at an especially sensitive time, too. At that point investors and traders were increasingly convinced that the dreaded sequester put into place as part of the last big debt ceiling deal in 2011 in order to force a comprehensive budget deal would instead of a deal wind up inflicting massive blunt force trauma on government spending. The sequester would impose $1.2 trillion in spending cuts over the next ten years on everything from the military budget (half of the cuts) to Head Start to low-income housing assistance to emergency preparedness. The Congressional Budget Office has estimated that the sequester would result in the loss of 750,000 jobs in 2013 alone.
And, unless the President and Congress can strike a deal sequester cuts start on March 1.
At about that same time, on February 28, investors and traders will also get the second estimate on U.S. GDP for the fourth quarter of 2011. The first estimate, released in January was disappointing. The U.S. economy actually contracted in the quarter, shrinking by 0.1%. Economists had expected weak but positive growth of 1% or so.
GDP growth is often revised upwards from the first to second estimate and from what I can gather there’s a sizeable group on Wall Street that is expecting that kind of trend reversal on February 28 too. That would be reassuring since it would remove some worry that political chaos in Washington might be enough to tip the economy back into recession.
But data that has come out since the first estimate suggest that we might not get a positive revision this time. Actual inventory figures, for example, showing a less than estimated drop in inventories, point to the possibility that the first estimate of GDP was actually too high.
Do I need to say that a second estimate that showed GDP shrinking by more than 0.1% in the fourth quarter would reinforce fears that the fiscal cliff and the sequester chaos had inflicted significant damage on the economy?
Those fears would come at a very sensitive time for U.S. stock markets. With indexes at all time or five-year highs, investors and traders have, of course, begun to worry about valuations and the possibility that the December/January rally has left the market at a peak with the next step downward.
Investors and traders looking for signs that they should stay in have drawn comfort from the still reasonable price-to-earnings ratios of U.S. stocks.
Yes, the argument goes, the trailing 12-month price to earnings ratio of the Standard & Poor’s 500 has climbed to 17.2 from 15.62 a year ago, but the forward price to earnings ratio—that is the PE based on projected earnings for the S&P 500 stocks in 2013—is just 13.5, according to FactSet.com.
At that level the market isn’t cheap. But it isn’t expensive either. Not expensive in the “about to peak” sense, anyway. A forward price to earnings ratio of 13.5 is above the five-year average of 12.8, according to FactSet. But it is below the 10-year average of 14.2.
So on the basis of this measure of valuation, there’s no reason to cut and run from these levels.
Of course, forward PE ratios are only as good as the projections behind them. This one is based on an increase in S&P 500 earnings per share to $112.93 from an estimated $102 a share in 2012.
But what if earnings don’t grow by 10% to hit $112.93? Any lag in the earnings growth rate pushes the price-to-earnings ratio of this market further above the five-year average and closer to the 10-year average.
Which is why the worries about Wal-Mart’s February sales and the impact of the fiscal cliff and the sequester are especially important at this juncture. If analysts are right about earnings growth in 2013, then the market has reasonable fundamentals under its recent rally. If, however, the warnings signs are meaningful and projected growth for 2013 is too high, then this market is more vulnerable to a correction. (It doesn't help that 2013 increasingly looks like a year when growth will be loaded into the second half of the year, making it especially hard to judge the accuracy of analyst projections over the next few months.)
Wal-Mart’s earnings announced yesterday were an early indicator of how badly political chaos in Washington has hurt the economy. (Comparable store sales, which grew by 1% in the fourth quarter, will be flat in the first quarter, the company said). But it’s by no means a final indicator. As we get closer to the actual sequester, I think anxiety will grow and we can expect Wall Street and investors to torture every number looking for clarity.
I don’t think they’ll get it easily or quickly. This is going to take a while to figure out. And in the meantime I think you can expect that the market will jump with every piece of data that promises an answer.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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