Price Check: Inflation Optimism and Stocks Rise After Mild PPI Report

Stocks got another jumpstart Tuesday with the second soft inflation reading in a week. October PPI growth slowed and was below analysts’ estimates, another sign that perhaps progress is being made on the inflation front. WMT earnings this morning also looked solid as the company worked its way through inventory.

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5 min read
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Key Takeaways

  • October’s Milder PPI Reading Gives Market a Solid Start

  • With Inventories Clearing a Bit, Walmart Earnings Easily Beat Expectations

  • Volatility, Dollar, Treasury Yields All Under Early Pressure

Shawn Cruz, Head Trading Strategist, TD Ameritrade

(Tuesday Market Open) For the second time in less than a week, investors saw evidence that Corporate America’s long inflation nightmare may be easing.

October producer prices rose just 0.2%, according to Tuesday’s Producer Price Index (PPI) report. That was below Wall Street’s 0.4% average estimate. Core PPI, which strips out food and energy, was flat last month. Analysts had expected an increase of 0.5%.

One or even two better inflation numbers isn’t a trend, so the Federal Reserve isn’t likely to pivot based on one month’s data. And inflation can always rear its ugly head. So, consider putting today’s reading into context. However, both today’s PPI and last week’s Consumer Price Index (CPI) data indicate we’re going in the right direction, and the PPI reinforced what we saw in CPI.

The Cboe Volatility Index® (VIX) remained below 24 early Tuesday, down slightly from yesterday’s levels. Other market metrics also fell this morning, including the benchmark 10-year Treasury yield (TNX) and the U.S. Dollar Index ($DXY). If you’re looking for direction in the stock market, it’s never a bad idea to check bonds and the greenback. Their weakness this morning cleared the path for the early rally.

Just In

Walmart (WMT) Delivers. The retailer’s earnings impressed investors this morning, who sent shares up 6% in premarket trading. The stats looked solid all around, with 8.7% revenue growth, 8.2% same-store U.S. sales growth, and a higher full-year outlook to reflect Q3 performance.

Grocery sales helped drive quarterly strength, the company said in its press release. Earnings per share and revenue both beat Wall Street’s average estimates.

  • On the inventory front, an area many retailers including WMT have struggled with, there’s progress,. Walmart’s inventory levels grew 13% in Q3, down from 25% growth in Q2. Even 13% is misleading, since those values are also driven mainly by inflation. On a unit basis, it’s much less.
  • Slowing inventory growth is healthy for WMT, but industrywide, overstocked inventories have led to markdowns that have possibly eased price inflation around the country. If inventories are becoming less of a problem, maybe companies won’t have to discount as much, leaving them in healthier shape.
  • On a sour note, WMT expects holiday quarter same-store sales, excluding fuel, to rise just 3%. That’s below Wall Street’s estimates and reflects WMT possibly being conservative about the consumer.
  • One thing that’s reassuring from the consumer perspective, however, is that WMT had a good quarter even though some had worried inflation would hurt WMT’s main customer base, which tends to be more vulnerable to rising prices. WMT’s earnings are a good sign that lower-income customers may be escaping the worst impacts of inflation.

WMT’s stock gains early Tuesday might be helping shares of competitors like Target (TGT) and Macy’s (M) as well.

Like a lot of companies this quarter, WMT announced a new share buyback plan. Buybacks are gaining popularity as many firms try to get ahead of a new law raising taxes on buybacks in 2023.

Home Depot (HD) Earnings Impress, Shares Don’t: Everything appeared to go right for HD in its earnings released this morning. Revenue and earnings beat Wall Street’s projections. Same-store sales rose 4.3%, above the 3.1% Wall Street estimate, and HD reaffirmed 2022 guidance. Nothing wrong there. Why are shares falling this morning? Perhaps some see the guidance as a bit conservative, but that stands to reason. HD benefited in a massive way from the recent housing surge, so it’s not surprising they’d see slowing growth. There’s nothing shocking there, and the stock is only down about 1%.

Of the two big-box retailers reporting this morning, WMT was the outlier, but in a good way.

A Glance Overseas: Soft data from Europe and Asia overnight might have weighed on Treasury yields. China’s October retail sales fell year-over-year, and Gross Domestic Product (GDP) lost ground in Japan. Sentiment data in Europe remained weak, though somewhat improved from the recent past.

Potential Market Movers

With these lower-than-expected PPI numbers, it will be worth watching how sectors react. Companies feeling less pain from rising wholesale prices will be less likely to pass along costs to their customers or eat costs that could hurt their margins. Lower wholesale price indicators will likely be a boon to industrial firms that have to pay up front for raw materials on the wholesale market. Think automakers, for instance.

Before the PPI results, there was unpleasant inflation news Monday from the New York Federal Reserve. Consumer expectations of inflation aren’t falling despite the Fed’s rate hike and hawkish words. Instead, they’re rising.

  • Consumers now see 5.9% inflation over the next year and 3.1% over the next three years.
  • They previously had expected 5.4% and 2.9%, respectively.

That’s the opposite direction the Fed wants to see, especially considering Fed Chairman Jerome Powell’s concerns about inflation expectations becoming “entrenched” and potentially driving future price gains.

This could be additional proof that it will take far more than a single bullish CPI report to reset consumer thinking. Especially if high-profile prices for things like food, gas, and rent continue rising. After all, it doesn’t help most people if used car or appliance prices fall, unless they have to buy one right away. For most of us, it’s the day-to-day costs like food and fuel that shape our expectations of the price environment, and those keep rising.

Lowe’s and Target Up Next

Some thoughts ahead of LOW and TGT earnings tomorrow:

Lowe’s (LOW): The last time Lowe’s reported, it was a mixed bag. Do-it-yourself (DIY) sales suffered, but sales to professionals and contractors looked solid thanks to company loyalty programs. However, the DIY cohort is more important for LOW than for Home Depot (HD) because HD is more of a contractor destination. The company guided toward the low end of its expected range and said the DIY side should improve in Q3.

Target (TGT): The main outstanding question is how has TGT performed on inventory over the last three months? Is the huge buildup seen earlier this year a bit more manageable now? And is the company still expecting operating margin improvement? One potentially helpful thing for TGT over WMT is its slightly more affluent customer base, which may be more able to handle this year’s stubborn inflation gains. Some analysts think consumers haunted by inflation will be out looking for discounts this holiday season, potentially putting more pressure on TGT to cut prices. But doing that would potentially hurt margins and earnings.

The retail earnings season getting underway today hit another snag yesterday when the media, including trade outlet FreightWaves reported that FedEx (FDX) is scaling back the number of flights it operates and putting aircraft in temporary storage to offset falling revenue from sinking e-commerce demand following a pandemic boom. Not the kind of news you’d expect to hear ahead of a healthy holiday shopping scenario.

Amazon (AMZN) announcing job cuts also clipped the retail sector yesterday (see more below).

Reviewing the Market Minutes

Stocks pulled back Monday after last week’s frenzied buying. It looked like the normal kind of consolidation usually seen the day after such rallies, according to Briefing.com, as many market participants looked back, shook their heads, and decided things had risen too much, too fast. Rising Treasury yields and a climbing dollar on the back of hawkish weekend Fed comments didn’t help.

Here’s how the major indexes performed Monday:

·    The Dow Jones Industrial Average® ($DJI) slid 211 points, or 0.63%, to 33,536.70.

·    The Nasdaq Composite® ($COMP) fell 1.12% to 11,196.22.

·    The Russell 2000® (RUT) lost 1.14% to 1,861.25.

·    The SPX decreased 35.68 points, or 0.89% to 3,957.25.

Getting technical, Monday marked the second-straight session in which the SPX managed to claw above 4,000 briefly intraday but wasn’t able to hold on to that level. That’s not a constructive sign for trading today, though it doesn’t cancel chances of a rally. On a more positive note, the SPX did finish above its 100-day moving average (MA), now just above 3,900. The 3,900 level also marked the upper boundary of a 3,700-3,900 recent range for the SPX, so keep an eye on whether it can continue holding the 100-day MA. 

CHART OF THE DAY: GREENBACK GIVEBACK: If you’re watching inflation, watch the dollar too. Last week, the U.S. Dollar Index ($DXY—candlesticks) fell 3.67% in two days, taking the greenback nearly 7% off its 52-week high. The dollar has strengthened against other currencies over the last two years but really accelerated earlier this year when the Fed started tightening the money supply. Using the thinkorswim® Fibonacci Retracement tool, we can see that the DXY has just broken through the 23.6% level. The next potential level of support is likely to be the 38.2% retracement level, which falls near 105. This level acted as support and resistance during the summer months. Data source: ICE. Chart source: The thinkorswim® platformFor illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Take a Breadth: Back in summer 2018, an almost unstoppable rally in the SPX drew most of its muscle from heavyweight mega-cap tech stocks that formed more than 25% of the SPX’s total value. Most of the other 490 stocks in the SPX barely gained as mega-caps partied. When mega-caps hit a wall that October, suddenly that emperor of a rally had no clothes, and the SPX slid nearly 20% by December 2018. Fast-forward to today, there are signs that recent market strength is much broader than it was four years ago. That could provide a firmer foundation for stocks to build on. For the week that ended November 11, all styles, sizes, and sectors in the S&P 1500® Composite rose in price, research firm CFRA noted Monday. 

And in a further sign of the rally’s breadth, CFRA said 91% of the subindustries in the S&P 1500 finished higher last week, adding that “93% of the subindustries are now trading above their 10-week moving average.” CFRA then added that improving breadth provides “potential for future price consideration.” However, looking backward, there’s still a bit of a catch. CFRA said only 54% of subindustries are trading above their 200-day MA and the SPX is already up 11.4% since September 30, implying “a breather might be in order.” But even if that’s the case, it looks like the market has a bit more muscle than it did in previous rallies. On the other side of the disagreement are analysts who argue that last week’s rally was dominated by “lower-quality” stocks, especially in the tech sector, that don’t have clear paths to profit.

Crypto Correlation: The debate continues whether last week’s crypto sell-off will have any “contagion” into the stock market.

Initial thoughts were that it won’t, simply because crypto is a small part of the market isn’t likely to have major impacts beyond the currencies themselves and crypto-related stocks. The other point of view is that all the money lost in crypto will have to be made up elsewhere by investors, meaning they may have to sell stocks to cover bitcoin losses. It’s difficult to track this unless you poll individual investors about why they’re selling, so we may never have a full answer. But stocks aren’t falling out of bed these last few days by any means.

Recently, the SPX had been showing a slight positive correlation with bitcoin, meaning they tended to move in the same direction more than in opposite directions. However, it wasn’t anywhere close to a perfect correlation. So, the failure of stocks to sell off with crypto after that one day of alarm last week makes sense in this context too.

Core Thinking: The U.S. Bureau of Labor Statistics divides its monthly CPI report into two categories: “all” prices and “core” prices, which does not include food and energy. October’s headline CPI rose 0.4% and core CPI climbed 0.3%. But what if the government’s core CPI data—now up 6.3% over the last year—is out of sync with real-world developments in one of its “core” components? Paul Krugman wrote in Sunday’s New York Times that current core inflation growth largely reflects a rapid rise in the official estimate of “shelter” prices, mostly resulting from high rents on apartments.

But most renters have long-term leases, so the average rents lag far behind the rents of new tenants, which reflect the current market. There’s a lot of evidence that new-tenant rents are now growing much more slowly after surging post-COVID-19. “Since shelter is about 40% of core inflation, it’s therefore not hard to make the case that ‘true’ core inflation is now well below 4%,” Krugman wrote. If he’s right, we could be closer to the Fed’s 2% inflation goal than many might realize.

Notable Calendar Items

Nov. 16: October Retail Sales and Industrial Production, and expected earnings from Lowe’s (LOW) and Target (TGT)

Nov. 17: October Housing Starts and Building Permits, November Philadelphia Fed Index, and expected earnings from Alibaba Group (BABA), Kohl’s (KSS), and Macy’s (M)

Nov. 18: October Existing Home Sales and expected earnings from Foot Locker (FL) and JD.com (JD)

Nov. 21: Expected earnings from Dell (DELL) and Zoom Video (ZM)

Nov. 22: Expected earnings from Best Buy (BBY), Autodesk (ADSK), Dick’s Sporting Goods (DKS), Dollar Tree (DLTR), Medtronic (MDT), and Baidu (BIDU)

Nov. 23: November Final University of Michigan Sentiment, October Durable Orders, October New Home Sales, and expected earnings from Deere (DE)

Nov. 24: Markets closed for Thanksgiving, reopening November 25. Have a great holiday!

Nov. 25: No important earnings or data scheduled

Happy trading,

Shawn

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Key Takeaways

  • October’s Milder PPI Reading Gives Market a Solid Start

  • With Inventories Clearing a Bit, Walmart Earnings Easily Beat Expectations

  • Volatility, Dollar, Treasury Yields All Under Early Pressure

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