Target misses target

Stocks traded higher yesterday after another inflation indicator came in lower than expected – which, in this case, is good. Geopolitical turmoil overshadowed markets when a missile mishap on the Polish border caused the algos to temporarily suspend the rally.

Deep breaths. What worries you most when you think about the economy? You are not alone if you answered inflation. It is clearly no longer just some obscure issue from the past. It is palpable and it has been eating into everyone’s budgets. Surely, the silver medal goes to a fear of recession. Recession, though it is certainly not a good thing and comes with lots of bad side effects, does not have the broad negative impact that inflation has, which is why it has been such a hot topic through this past election season. It has also, in case you haven’t noticed [clears throat], been a hot topic in my daily writing. I often like to remind my readers that inflation has been the cause of many heads being separated from bodies in history. Equally painful and possibly even more gory has been the decapitating effect that inflation has been having on our portfolios. Rising interest rates resulting from monetary tightening is the principal cause for the trailing twelve month -29% deficit of the growth-heavy Nasdaq. Now, in its final act, inflation is directly affecting corporate earnings growth, with little discrimination between growth or value stocks. Companies have their own challenges. Rising input costs first ate into profitability. Not too long after, companies raised prices to maintain margins. Margins are now still under pressure, and fading consumer demand is putting pressure on revenues, further accentuating margin pressure. Due to softening demand, companies will, at some point, be forced to lower price points to stay alive. Profitability? Companies will hope that input costs will ease back to normal.

Yesterday morning, I referenced Walmart as being a canary in the coalmine and just as I sent out my note, the company announced earnings which exceeded analyst targets. The company’s narrative gives us some interesting insight. Walmart’s initial warning came a few quarters back when it began to experience a shift in spending from hard/soft lines to food, driven by higher price points. While widescreen TVs and snazzy fashion is nice, they are not as nourishing as say, a head of lettuce or scrambled eggs. Well, in this latest report, the ubiquitous mass retailer admitted that the shift into groceries persists and that it has witnessed softer demand in electronics and clothing. Walmart has also noted that there has been a rise in wealthier consumers searching for bargains, another sign that inflation is impacting consumer spending habits. Presumably, these newfound wealthier clients are spending less of their dollars somewhere else. Higher end retailers will hit the tape with earnings announcements in the coming days … eyes open.

Some more important consumer data came to us this morning WHILE YOU SLEPT, from Target (TGT), which announced a disappointing earnings miss. The company warned that consumers are pulling back and as a result, Target lowered its forward guidance. The CEO directly referenced inflation and rising interest rates as the cause of the decay in demand. Perhaps a quote from the company’s Chief Growth Officer best sums up the situation. She spoke of same store sales peaking in September followed by a continuous fall thereafter. She referred to it as a “precipitous decline.” You know things are tough when a person with the word “growth” in their title uses the word “decline” in a statement and further embellishes with a polysyllabic adjective like “precipitous”. There was a hint of positive information in the announcement, though it may not be obvious. Target, like Walmart also had a bloated inventory problem a few quarters back as consumers shifted to groceries. Target announced that it managed to get its inventory back to normal by lowering prices. Further, Target noted that consumers were more likely to purchase items on sale… aka lower prices. So, are these early signs that consumer inflation is on the retreat? Let’s hope so. With lower prices expected, will companies be able to remain profitable in future quarters?

As referenced above, company profitability as consumer prices decline will be determined by costs. Supply chain problems were the initial drivers of inflation, beginning in early 2021, and there are some early signs that those challenges are beginning to ebb. Yesterday’s release of the Producer Price Index / PPI, which details costs borne by producers, came in with a lower than expected +0.2% monthly gain while the prior month’s release was revised downward. Looking at the yearly change we note what appears to be a peak in early summer, however at +11.2%, we still have a long way to go before producer prices get back to their pre-2020 levels (see chart of annual PPI change below). We may find some solace if we look at a graph of the month over month change. In the monthly chart below, we can see that the elevated monthly moves that began in 2021 and persisted through most of the current year have simmered down, with the last 3 readings being more in line with its historical norms. This may be an early sign that input cost pressure on companies may be waning. This would give companies room to lower prices while maintaining margins. Stay tuned for more retailer earnings reports later this week.

WHAT’S SHAKIN’

Target Corp (TGT) shares are lower by -13.97% in the premarket after it announced a -28.40% EPS miss. The company lowered forward guidance noting a decrease in demand. Other retailers are falling in sympathy in the premarket. Dividend yield: 2.12%. Potential average analyst target upside: +7.5%.

Lowe’s Cos Inc (LOW) shares are higher by +1.51% in the premarket after it announced that it beat EPS and Revenue estimates by +5.99% and +1.48% respectively. The company also raised its future guidance slightly. Dividend yield: 2.01%. Potential average analyst target upside: +12.4%.

YESTERDAY’S MARKETS

Stocks traded higher yesterday after the PPI came in lower than expected prompting hopes that inflation will soon be under control and that the Fed can give up on aggressive rate hikes. The S&P500 gained +0.87%, the Dow Jones Industrial Average added +0.17%, the Nasdaq Composite Index jumped by +1.45%, and the Russell 2000 Index advanced by +1.5%. Bonds gained and 10-year Treasury Note yields gave up -8 basis points to 3.76. Cryptos climbed by +3.65% and Bitcoin advanced by +3.08%.

NEXT UP

• Retail Sales (October) is expected to have gained +1.0% after being flat in September.
• Industrial Production (Oct) is expected to come in with a +0.1% growth, slower than the prior periods +0.4% climb.
• NAHB Housing Market Index (November) may have declined to 36 from 38.
• Today’s Fed Speakers: Williams, Barr, and Waller.
• After the closing bell earnings: Cisco Systems, NVIDIA, and Bath & Body Works.