Talk of trade wars became a reality this last week but many still hold out to the view that these ar...
The Dire Warning from Walmart
02/22/2013 11:16 am EST
E-mails from inside the giant retailer, echoed in its profit report, show how Washington's mess of budget cuts and tax hikes will hurt the economy and hamper the market, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
Call it Walmart-gate.
Bloomberg's publication of e-mails from the vice president of finance and logistics at Walmart Stores (WMT) won't bring down a president, but they were certainly enough to rattle the stock market this past Friday.
And I think those comments continue to hang over stocks and explain a good part of recent weakness and volatility. Especially since they were been echoed in the company's fourth-quarter earnings results.
In fact, I think the issue raised by these e-mails is the single scariest thing hanging over the stock market.
E-mails from Walmart scarier than the Federal Reserve minutes casting doubt on the US central bank's commitment to economic stimulus via bond buying? Scarier than the currency wars launched by Japan, which 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.
Those e-mails are especially scary for US stocks. Right now, with US market indexes near five-year or all-time highs, markets could head one of two ways: into a consolidation that builds a base for a run higher, or into a correction that could take stocks down 7% to 10%, in a replay of the spring and fall 2012 corrections.
Why could e-mails from Walmart help decide which way the market goes in the short run? Because some very big short-term worries could all line up in the next few weeks. Walmart's warning is part of that pattern. Let me explain.
The World from Walmart
In case you've forgotten, here's the really explosive quote from the e-mails published by Bloomberg: February sales are a "total disaster." The Walmart 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 Walmart-specific bad news—is that the February crash in sales was an indicator of damage done to the US economy by the end-of-the-year fiscal cliff chaos and the eventual deal on January 1.
The Payroll Tax Hike
That deal, you'll remember, included the expiration of a 2-percentage-point cut in FICA, the Social Security payroll tax. In order to stimulate the US 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 lower spending by these families, and lower 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 immediately.
Walmart's bad sales in early February seemed to confirm the reality of these fears. (It didn't help that, because of the chaos of the fiscal cliff crisis, the Internal Revenue Service delayed processing of early tax returns. Many Walmart shoppers file early and then use an early refund, or an early tax-refund check from a tax preparer, to make a major purchase or two in the early part of the year.)
The Walmart e-mails hit the stock market at an especially sensitive time, too. At that point, investors and traders were becoming convinced that the dreaded sequester budget cuts, put into place as part of the debt-ceiling deal in 2011, would kick in and inflict 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, the sequester cuts start on March 1.
At about that same time, on February 28, investors and traders will also get the second estimate on US gross domestic product for the fourth quarter of 2012.
The first estimate, released in January, was disappointing. The US economy actually contracted in the quarter, shrinking 0.1%. Economists had expected weak but positive growth of 1% or so.
GDP growth is often revised upward from the first to second estimate, and from what I can gather, there's a sizable group on Wall Street that expects that kind of trend reversal on February 28. 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 have come out since the first estimate suggest that we might not get a positive revision this time. Actual inventory figures, for example, show a less-than-estimated drop in inventories, pointing to the possibility that the first estimate of GDP was actually too high.
Do I need to say that a second estimate showing the 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?
Flying Too High?
Those fears would come at a sensitive time for US stock markets. With indexes at all-time or five-year highs, investors and traders have 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 US stocks, a standard measure of whether stocks are fairly priced.
Yes, the argument goes, the trailing 12-month price-to-earnings ratio of the S&P 500 has climbed to 17.2 from 15.62 a year ago, but the forward price-to-earnings ratio—that is the P/E based on projected earnings for 2013—is just 13.5, according to FactSet Research Systems.
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 ten-year average of 14.2. So on the basis of this measure of valuation, there's no reason to cut and run.
Of course, forward P/E 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 ten-year average.
The Walmart Indicator
That's why the worries about Walmart's February sales and the impact of the fiscal cliff and the sequester are especially important now.
If analysts are right about earnings growth in 2013, then the market has reasonable fundamentals under its recent rally. If, however, the warning 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.)
Walmart's earnings announcement was an early indicator of how badly political chaos in Washington has hurt the economy. The company announced a higher profit in the completed fourth quarter, but—as in the e-mails—warned of weak sales in the current quarter.
This is 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 clarity can be gotten 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 react to every piece of data that promises an answer.
Jubak Global Equity Fund, 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. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.
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