Gaining Elevation

by Shawn Narancich, CFA Senior Vice President of Research

Dow 16,000

A slow growth, low inflation environment that continues to enable highly accommodative monetary policy remains a recipe for stock market success. With year-to-date gains now topping 25 percent on the S&P 500, the venerable Dow surpassed another 1,000 point threshold as key equity benchmarks forge further into record territory. With retailers book-ending third quarter earnings season this week, investor attention is being redirected back to the global economy, where key U.S. reports continue to indicate the possibility but not likely the probability that the Fed will begin tapering its program of quantitative easing before year-end. Domestic inflation decelerated for the third consecutive month in October, to an annual rate of 1.0 percent not seen since deflation beset the economy in 2009. With next to no wage pressure and a domestic energy boom keeping natural gas and oil prices well contained, incoming Fed Chair Janet Yellen can afford to be patient. Will Ben Bernanke presiding over his next-to-last FOMC meeting next month steal her thunder? Barring a surprisingly strong November jobs report, probably not. Those betting on an early taper would point to last month’s better than expected payroll gains and this week’s surprisingly strong retail sales report, in which strong auto sales, restaurant spending, and furniture sales drove better-than-expected 3.9 percent growth.

Crystal Clear

While retail sales were surprisingly robust in an October disadvantaged by the partial government shutdown, investors are clearly witnessing a case in which a rising tide is not lifting all boats. In the plus column is Home Depot, which posted U.S. same-store sales exceeding 8 percent for its fiscal third quarter. For a retailer with $80 billion of yearly sales, such growth is impressive and speaks to where consumers are spending – on durable goods like washing machines and new carpet for a typical house that now has home equity. Where consumers are not spending as much is in categories like apparel and center aisle grocery, negatively impacting the likes of Target and packaged food companies Campbell Soup and JM Smucker. In contrast to another beat-and-raise quarter from Depot, each of the aforementioned fell short of investor expectations, with the stocks being summarily punished.

Winners and Losers

In an environment of muted wage gains and still elevated unemployment, consumers are increasingly price sensitive, but in contrast to past economic cycles, technology has enabled them to be smarter shoppers. Armed with smart phones able to compare prices across retailers and internet sites at the touch of an app, bricks-and-mortar retailers like Best Buy are having to offer price matching (think deals on Amazon) to keep up with online competitors. While Best Buy’s stock has performed spectacularly this year (up 231 percent year to date), it suffered a setback earlier this week because same-store sales missed expectations and the company warned of a heavily promotional holiday season.

Our final observation from the land of retail would be the high-end, low-end dichotomy. We expect the Nordstroms and Louis Vuittons of the world to post much healthier Christmas sales than general merchandisers like Wal-Mart, Target, and Kohl’s, reflecting lower rates of unemployment for college educated, upper income shoppers and record stock prices that are having a beneficial impact on higher-end spending.

Our Takeaways from the Week

  • Stocks are setting new highs amid a benign economic backdrop
  • Retailers concluded the third quarter earnings season, reporting mixed results

Disclosures