Quote of the Week
“There are two ways of spreading light: to be the candle or the mirror that reflects it.” – Edith Wharton
Last week was a slightly down week for the markets. It would have been a bad week except for a good rally on Friday. The Dow was down -0.2%, the S&P 500 was down -0.9% and the Nasdaq was down -1.6%.This week started out down but on Tuesday and Wednesday we have seen a good upward spike in the markets. I just want to remind you that these types of rallies are common in bear markets.
Now we are starting into earnings reporting season. So far with 37 companies reporting corporate earning are down -14%. In the two prior week’s letters on June 27and July 4, I discussed how the first leg down in this bear market has been due to a valuation discount. That leg down was about -20% and now we are starting into the corporate earnings leg down. Based on the data that we are seeing which is bad, this corporate earnings decline could last through the fourth quarter.
If in fact we see this corporate earnings decline over the next six months we will definitely be avoiding investing in the stock market. If interest rates start to decline which we expect that they will, our best position will be the bond market. Remember when interest rates decline, bond prices go up.
All hope is not lost. We have been through this before. In theory, if interest rates do decline, we will get appreciation in our bond positions. At some point in time we will hopefully be able to re-invest in the stock market at bargain valuations.
Last week we got the inflation number for the month of June. Year over year the increase in inflation was a +9.1%. This number certainly looks terrible. However looking under the hood, most of the increase was due to rising gasoline costs. Nationally the cost of a gallon of gas in June was $4.93 per gallon. So far this month gasoline has come down considerably. Yesterday I filled our car at Costco for $4.19 per gallon.
We think inflation will be lower for the month of July and will continue to decline for the rest of 2022 barring some sort of global shock to the oil market which certainly could happen. Many of the soft commodities such as wheat, corn, and soybeans have come down over 25%. Also industrial metals have also come down around the same amount. If we do see a decline in inflation, it will tend to cause long term interest rates on bonds to fall which would be good for our expected positions in bonds.
As of now we are positioned in 73% in cash, small positions in the US dollar, China, private equity, plus global bonds. We are waiting for the go signal to start adding to our bond positions.
For the last few months all the business shows and publications are touting how healthy the consumer is doing. They are pointing to the fact retail sales were up last month and that the consumer has money in their pockets to burn. This is not true. Yes retail sales were up but the consumer is getting 9.1% less for the dollars they spend.
The following article from Real Economy points out that the consumer is actually in trouble. The article is dated in June but I think you will get the picture.
U.S. retail sales fall as inflation takes a toll
JUN. 15, 2022 BY TUAN NGUYEN
U.S. retail sales declined in May as surges in energy and food prices forced consumers to reduce their spending on vehicles and other discretionary items. With inflation running hot, sales plunged on an inflation-adjusted basis, paring most of April’s gains.
That implies more headwinds to consumer spending in the second quarter. But it won’t be the Federal Reserve’s top concern as it focuses on reducing inflation, starting with a 75 basis-point rate hike announced Wednesday.
Retail sales dropped by 0.3% in May, a decline from a downwardly revised 0.7% increase in April, the U.S. Census Bureau reported on Wednesday. Our estimate pointed to a decline of 1.0% in sales after adjusting for inflation.
Note that data on retail sales mostly represents spending on goods, which has been declining on an inflation-adjusted basis since April of last year.
In fact, slowing goods spending or even outright declines could be welcome for the Fed as goods inflation has contributed about 20% to the headline year-over-year inflation figure.
We expect sales to drop further in June as gasoline prices continue to rise and consumer sentiment drops to a record low.
Spending on vehicles led the decline, down by a sharp 3.5% on the month as prices increased by 1.4%, according to consumer price index data last week. That suggests an even sharper drop in sales volume for vehicles in May. Vehicle sales account for a third of total retail sales—the largest component.
Gasoline prices reached a new high in May, rising by 4.0% on the month. Spending at grocery stores rose by 1.2% from a month earlier, mostly because of higher food prices.
As a result, the share of sales at gas stations and food stores rose for the third time in four months, to 21.5%, after a brief decline in April. That means less spending on discretionary items because of persistent inflation.
The control group—which excludes vehicles, food stores, gasoline and building materials—was flat on the month, not enough to offset the monthly price gains. Last month’s data was revised downwardly to an increase of only 0.5%. The control group feeds into the quarterly calculation of gross domestic product. The drop wiped away gains in April, implying declines in Sales from online retail stores dropped by 1.0% in May while electronics and furniture sales also dropped by 1.3% and 0.9%, respectively. the goods-spending component of GDP in the second quarter.
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