Just as the market was providing an all-clear signal for a meaningful bounce from the bottom, then came along two of the scariest earnings reports in memory, states Steve Reitmeister of Reitmeister Total Return.

Of course, I am referring to the back-to-back reports from Walmart and Target that sent shivers through the spine of all investors. The reason why is obvious. If the two largest retailers on the planet are having this large of a problem dealing with inflation, then it increases the odds of recession and bear market.

This led to a retest of the S&P 500 (SPX) bear market territory at 3,855. Even getting as low as 3,810 on Friday before bouncing to 3,901 at the close. That bounce extended further to 3973.75 on Monday.

That is the past...what does the future hold?

Answering that question is not easy...but we will try our level best in this week's Reitmeister Total Return commentary. Given that I gave a pretty thorough review of this in Friday’s POWR Value commentary, then we will lay that out below followed by some further thoughts as it applies to Reitmeister Total Return.

I have to be honest. I was truly shaken by these back-to-back earnings misses from the two largest retailers. On the surface, it screams recession! However, I knew there was a person I could turn to answer. I am referring to Sheraz Mian, Director of Research at Zacks. He and I worked together for many years when it was very clear there was no one on the planet who understood earnings trends better than he did.

So let’s start with the insights he shared with the world in this article: Making Sense of Target, Walmart, and disappointing retail results. Here is the key excerpt: “It is tempting to interpret the Walmart (WMT) and Target (TGT) earnings disappointments as indicative of moderation in consumer spending. Faced with the rising costs of fuel and other essentials, not to mention growing talk of a slowing economy in the face of rising interest rates, consumers would be justified to rein in their spending to some extent.

We see the Walmart and Target reports as still reflecting a very strong consumer spending environment. Consumer spending will eventually slow down in response to Fed tightening, but we didn’t see much evidence of that in the Q1 earnings reports; neither from Walmart, Target, or other consumer-centric companies.

Instead, these big-box retail leaders missed as a result of weak execution and failing to have the right merchandise in stores. Consumers didn’t buy the patio furniture at Walmart or appliances at Target, but they did plenty of shopping at Home Depot.

The challenge for Walmart, Target, and other retailers is not only to have the correct merchandise, but also to deal with higher expenses related to freight, payroll, and other items.

You can see this in the -24.4% decline in Walmart’s Q1 earnings even as its revenues increased +2.4%. For Target, earnings declined by -44.9% while revenues were up +4%. The market expects these companies to pass on these higher expenses to either their customers or squeeze them out of their suppliers.

The market punished them for being surprised at the profitability hit even as they failed to protect their margins.”

After reading the above, I emailed Sheraz directly for more insights. For which he gave me a lengthy response that on the surface did not soothe my nerves: “…inflation is a problem...for consumers as well as the companies. The Fed must be happy to see that WMT and TGT ate the cost increases, squeezing their margins, instead of passing those onto consumers. What happens to inflation when WMT/TGT passes on those higher expenses to consumers? TGT said that they are spending $1 billion incrementally more this year on freight...which they didn't pass on. 

I have been looking for some early signs of weakness in consumer spending and I don't think these reports or earlier ones from the likes of PG gave us such evidence. That doesn't mean it wouldn't happen in three months or six months, but it hasn't happened yet. The Fed wants to weaken the consumer, so it will happen (don't fight the Fed, remember), but it's down the road.” 

This response seemed a bit ominous to me…as if Sheraz was saying that a recession is right around the corner. If so, then with investors often forecasting things well in advance, the market as a whole is right to head into bear market territory now because of a looming recession. Here was his follow-up response:

“There is no recession near term....meaning in the next six months....there are simply no signs at this stage that we are getting there. The market is fearful of a recession and starting to price that in...hence all the red prices. Goldman says there is a 30% recession risk, in 2023. These are hard things to predict, but those odds look reasonable to me. This means that we will see more signs of recessionary weakness in the next couple of quarters. Keep in mind that the Fed is data-dependent, so its monetary policy outlook will adjust as those recessionary signs emerge in the next couple of quarters. That is the soft-landing scenario, which is my view as well. The economy weakens, and the market's inflation expectations come down, causing the Fed outlook to change. That's when the market takes off. Till then, we are in trouble.”

Yes, that last part is ominous. But I read it as stocks will have a hard time making a meaningful bounce until there is proof of a soft landing allowing the Fed to adjust their outlook and policies. Or to put it another way, we are still in a wait-and-see mode similar to what we discussed last week as path number two for the market. Here is that explanation again:

Consolidate Here and Delay Bull/Bear Conclusion

"Remember that relief rallies are typically +3-5% before testing lower once again. And that’s pretty much the size of the bounce we got Thursday afternoon through the end of Friday. So it’s not hard to imagine that we spend time in a trading range between the border of bear market territory at 3,855 and 4,100. Meaning that bulls and bears battle it out a bit longer before making the final determination if we do tumble into bear market territory or bull re-emerges. We all would prefer the former choice. And can even make logical presentations showing why that is the more likely outcome. Unfortunately, we do have to appreciate that the combination of high inflation and hawkish Fed is not the most stock-friendly environment. Not a guarantee of a bear market…but fertile soil that could support the growth of bearish conditions. Add it all up and we are not that far off the divergent paths discussed last week. And that keeps us in wait-and-see mode.

Wait and see mode = that just like the Fed we are data-dependent to change our course of action depending on what happens next in the economy, sentiment, price action, etc. But for now, our course is that risk and reward are fairly well balanced at this time. Don’t get too much more aggressive in case the market does devolve into a bear market. Don’t get too much more defensive in case new bullish catalysts emerge with a meteoric bounce ensuing. Just hold tight for now.”

Over the weekend I prepared a range of trading strategies for Reitmeister Total Return that would allow us to get more defensive. But first I knew that a bounce was coming to at least retest 4,000 and perhaps 4,100 which technicians like JC Parets of AllStarCharts.com believe is the real battle area for the heart of this market (above it and likely this correction is over).

These potential trading strategies were about getting more defensive in a hedged portfolio. But how hedged did I want to be out of the gate? So I actually wrote up three different scenarios that are at the ready between 33% net long to 40% to 50%. Yes, they seem like subtle differences on the surface…but each required additional sales or purchases. And just wanted a range of choices at the ready to go faster from thought to execution.

Please do realize that these plans may never see the light of day. That’s because there are some who believe the bear market has already taken place. It was just more concentrated in overvalued growth stocks. That view of things is heard loud in clear in Cathie Wood’s dreadful results. Or consider the average 37% decline for investors this year according to TipRanks measuring of performance from over 500,000 portfolios in their systems (more on that in the Portfolio Update section below).

Yes, a lot of that pain spilled over to other company shares…but less so which is why the S&P still has not tipped over the vaunted 20% line that spells a traditional bear market.

The point is that with no recession in sight it is hard to ask the overall market to head lower than it has already. The evidence of the “no recession” conversations is best understood by the current +2.4% Q2 growth estimate from the Atlanta Feds GDP Now reading. That is nearly a full one point above where it started at the beginning of the month.

Then today you have the lesser followed Chicago Fed National Activity Index, which as the name implies, looks at the totality of the US economy. There we saw an increase from +0.36 to +0.47. (Under zero is a sign of contraction and +0.47 is a healthy notch above.) Putting it all together, the “wait and see” mode continues. But as already shared, we have contingency plans at the ready to get more long or short the market as needed.

Stay alert…and stay nimble for what comes next.

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