The Pause That Refreshes... or Something More Sinister?

by Shawn Narancich, CFA Vice President of Research

A Pause that Refreshes? More than halfway through February, investors experienced a weekly loss in U.S. stocks for the first time this year. But a small pullback in blue chip equities masked potentially more troubling undercurrents. Release of the Federal Reserve’s minutes recalling details from its January meeting forced investors to confront the prospect of less accommodative monetary policy, namely the potential for our central bank to reduce quantitative easing prior to reaching its previously stated goal of reducing unemployment to the 6.5 percent level. To steal a phrase from JP Morgan CEO Jamie Dimon, the published debate amongst Fed officials appears to be a tempest in a teapot. Judging by yesterday’s CPI release showing the slowest rate of inflation since last July (at 1.6 percent), minimal pricing pressure appears far from that which would cause the Fed to take its foot off the gas in a race where unacceptably high unemployment has lapped the economy. As stock prices hesitate, the bond market appears to be confirming a default assumption of a slow growth, non-inflationary economy, evidenced by benchmark 10-year Treasury yields retreating back below the key 2 percent threshold. What fails to confirm a muted economic outlook, one likely to require additional monetary stimulus, is gold pricing, which has now fallen 6 percent so far this year and 12 percent since last fall.

Canary in the Coal Mine Consumers are facing a triple threat of higher payroll taxes, gasoline prices up 50 cents a gallon in the last month, and tax refunds delayed by the fiscal cliff debate at year end. If bellwether Wal-Mart’s quarterly earnings are any indication, these factors are beginning to weigh on consumer spending, the most critical driver of U.S. GDP. While earnings at the nation’s largest retailer beat expectations, Wal-Mart missed sales expectations and met bottom line estimates primarily because its tax rate dropped. Despite poor earnings quality, investors reacted warmly to an 18 percent dividend increase and management disclosure that sales had begun to pick up most recently. Nevertheless, America’s mass retailer of choice offered up expectations for flat sales in the current quarter, leading investors to question how lasting the apparent pullback in consumer spending might be. With the negative economic impact of sequestered spending cuts one week away, investors can be forgiven for thinking we are due for a more substantial pullback in a stock market experiencing its best start to a year since the early 1990’s.

Sell the Rumor, Buy the News Proving Wal-Mart’s mantra that low priced goods attract buyers, Hewlett Packard’s discounted stock price received a much needed boost after reporting better than expected sales and earnings following a series of well-publicized shortfalls over recent quarters. Despite reporting sales declines in every one of its divisions, the stock rallied over 12 percent on evidence that the company retains a heartbeat.  Based on upbeat management commentary, investors are left to conclude that CEO Meg Whitman and her team have finally lowered earnings expectations far enough that even a business in secular decline can clear the bar. One thing is for sure, spending on PC’s and printers is no longer a priority for either corporate America or the average consumer, a stark reality that will continue to challenge HP in a technology world now dominated by tablets and smart phones.

Next week, investors will see the last vestiges of Q4 earnings, book-ended by retailers like Target and Home Depot that have yet to report. Once again, corporate America has proven adept at under-promising and over-delivering, but earnings estimates for 2013 continue to moderate in a slow growth world.

Our Takeaways from the Week

  • Stock prices finally paused as U.S. consumer spending slows
  • After a decade long run, gold has become a notable underperformer