Beware a Walk Over Coals

Walmart's recession-proof business... Discerning spenders are more frugal... A garden-variety correction or a walk over coals?... All we can do is weigh risk... Holy bond yields... Things are happening with the yield curve again...

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Picking up where we left off yesterday on U.S. retail...

This morning, America's largest retailer – Walmart (WMT) – reported its latest quarterly financials. They told a similar story to what we described yesterday... which was "resignation" on the part of U.S. consumers.

According to the folks leading the largest U.S. retailers, customers are increasingly spending on what they need more than big-ticket items that they might want to buy instead... And this shift is significant, considering about 70% of the U.S. economy is tied to consumer spending.

Walmart beat Wall Street consensus expectations for sales and profits for the quarter. And the company actually increased its full-year net sales outlook from 3.5% to between 4% and 4.5%.

In short, the company showed why it is "recession proof," as we have shared here before, and we're not even in an official recession. (Though that could still be ahead... more on that momentarily.)

More people used the company's online offerings last quarter. Americans also keep buying food at Walmart, which is the country's largest grocer with 25% of market share.

Yet at the same time, various company leaders shared insight that suggests a "choiceful and discerning" customer overall, as Walmart's Chief Financial Officer John Rainey said in an interview today.

That's a better description than 'resilient,' but it doesn't quite cover everything...

Walmart's U.S. CEO John Furner said on an earnings call with Wall Street analysts that its limited-time "Rollback" deals have been very popular... sales of private-label Walmart groceries rose 9% year over year... and general-merchandise sales are down year over year.

Maybe most telling, Rainey said on CNBC that the company will monitor the amount of merchandise it orders moving ahead, and he struck a cautious tone overall. He said...

While inflation is moderated and employment levels have been steady, credit markets have tightened. Energy prices are higher and some customers face additional expense from the resumption of student loan payments in October.

As such, we continue to be appropriately measured in our outlook.

If this sounds conservative with a dose of recessionary flavor to you, I (Corey McLaughlin) agree. And as I will explain today, this conversation – and perhaps growing expectations for more of the same ahead – may be what we're seeing reflected in recent market action.

Is this a 'garden variety' correction, or something more?...

After a third straight down day today, the S&P 500 Index is off more than 4% since its most recent closing high on July 31... And after recent trading, it has been below its 50-day moving average for three straight days for the first time since the banking crisis in March.

The U.S. benchmark and the other major indexes remain in a longer-term uptrend since last October. But if this recent turn continues, the S&P 500 would have another 6% or so to fall before meeting its current 200-day moving average, a technical measure of a long-term trend.

Notably, as we've mentioned lately, the U.S. dollar continues to strengthen relative to other major global currencies. The U.S. Dollar Index ("DXY") is up nearly 4% since a July 18 low. This has been a major headwind for stocks over the past few years.

Maybe stocks will start turning around tomorrow or next week. I can't say for sure that they will or will not.

All we can do is weigh risk...

That's what our Ten Stock Trader editor Greg Diamond told his subscribers today when he suggested closing out a pair of bullish positions for gains of roughly 20% and 5%...

The market is going to do what it's going to do... When I see a bullish setup fail, it makes me cautious. So we take off some risk and focus on what's next...

Some folks may not like doing this, but managing risk is what separates the winners from losers over the long term...

When I consider what has happened already and what could come next, I see a potential 10% hit before the S&P 500 would meet its longer-term average, which sometimes ends up aligning with a technical "support" level.

Back in the old days before the pandemic, during what was then a record-long bull market, a 10% pullback was considered a "garden variety" correction. No big deal.

It could end up being the same today... But given the current state of affairs in the U.S. – still-high inflation, continued monetary-policy uncertainty, perhaps more recession talk (and reality) ahead, lingering shell-shock from market performance in 2022, and polarized national politics getting back to the forefront – it might feel more like a walk on coals rather than a stroll in a garden.

Take note...

Maybe the major U.S. indexes will stop falling soon. Next week's central banker confab in Jackson Hole, Wyoming might have something to do with that. Federal Reserve Chair Jerome Powell will take the stage again and could answer some questions about future policy plans... and could ease some fears.

But there could be some more downside ahead, too. Hints of additional central-bank rate hikes are a particular risk, given that gross domestic product ("GDP") for the quarter is projected to rise nearly 6% annualized, reported unemployment is still low, and the Fed's preferred inflation measure remains above 4%.

That's certainly not a picture of helping ease inflation over the long run.

Maybe this is why, for the first time in this rate-hiking cycle, I've seen bond traders starting to place small bets on a near 6% fed-funds rate by November. That is according to the CME Group's FedWatch Tool.

Holy bond yields!...

The 10-year U.S. Treasury yield has been on the move lately, hitting more than 4.3% today, a level it last reached back in October 2022 (and before that, 2008!). The former is notable because it's when the major U.S. stock indexes put in a bottom.

The 10-year yield revisiting this level could be a signal that inflation and interest-rate expectations, which also bottomed back in October, are on the rise again in the market. When these factors are in play, the 10-year Treasury's yield must rise to compete with higher rates on newly issued debt (driving down the prices of existing Treasury bonds).

One indicator also suggests the bond market's recent behavior could also mean that a recession may be on the way – even if Powell and Treasury Secretary Janet Yellen insist it's definitely not coming... or at least that more investors are preparing for one.

I keep going back to the most relevant history we have...

In the past few years, we've experienced high inflation and fast-rising interest rates. Our parallel is back in the late 1970s and early 1980s, back when the yield curve was last as inverted for as long as it has been now because of persistently high inflation.

This period was when short-term yields, like the 2-year or 3-month or effective federal-funds rate, were higher than the 10-year or 30-year. As we've mentioned before, only after the yield curve began to "get back to normal" in these instances (and the others since) did a recession follow – and stocks hit a related bottom.

Back in June, we shared this chart via Stansberry NewsWire editor Kevin Sanford...

Perhaps not coincidentally, stocks dropped around 13% during the "inflationary periods" where the yield curve was as inverted for as long as today in both 1980 and in 1981.

And these declines happened amid what were considered "official" recessions.

In other words, a 10% drop in stocks would be completely "normal" in today's circumstances. Whether that happens within the next few weeks or months from now, we can't be sure. But here's what we can say...

Today, we might be seeing the very early signs of yields starting to revert – again...

We saw some of this back in March during the bank crisis. But after the Fed stepped in with emergency rescue measures, the story returned to the status quo.

But rather quietly over the past few months, and more noticeably lately as the U.S. stock indexes have weakened, Treasury yields have started to "revert" again... Take a look...

While the 10-year yield was up today, the 2-year yield was actually down. It's a similar story with the 10-year/3-month Treasury spread, which some people like to follow, too, for the same reasons.

Again, you might take this behavior as good news and a sign of things getting back to normal. It will be both eventually... But it also means the erstwhile recession could finally show its face later this year or early next year. It can be a tricky situation to navigate...

In other words, don't get complacent.

If you're thinking about taking profits on a trade, now might be a good time. But remember your timeline and goals, too... And remember that cash will lose value in this inflationary world. Short-term yields, like a 3-month Treasury bill still offering nearly 5.5% annualized, may be appealing to you to grow cash on hand.

And over the long run, owning shares of high-quality stocks that can keep rewarding shareholders is always better than not.

New 52-week highs (as of 8/16/23): None.

In today's mailbag, feedback on yesterday's Digest in which we questioned the "resilience" of the American consumer... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Good day, Corey. Excellent Digest (as per usual) and could not agree more with your thoughts on the word 'resilience' in reference to consumers. Hearing economists, politicians, et al say 'consumers are resilient' along with phrases such as 'flush with cash'... 'excess savings'... considering the reality of most folks, seems akin to saying an unprofitable debt-ridden zombie company has a 'great balance sheet'. This resilience may be true for the top few percent whose wealth has grown most, but the majority of people have a different story..." – Subscriber Jeremy W.

Corey McLaughlin comment: Thanks for the note, Jeremy.

I'm preaching to the choir here with you... But there sure seems to be a large discrepancy if so many people shopping at major U.S. retailers are reportedly "flush with cash" and have "excess savings" – yet Americans are racking up record amounts of credit-card debt and avoiding big-ticket purchases while still spending on the necessities.

I think your point about how "this resilience may be true for the top few percent whose wealth has grown most, but the majority of people have a different story" is spot on.

This has been true for a long time, but the more income a person or household makes, the more likely they are to have savings...

A recent Bankrate survey of 1,000 Americans, for example, showed that 75% of those making $100,000 or more per year said they had enough savings to cover three months of expenses or more... and 50% felt they had enough to cover six months or more. Far fewer of those making under $50,000 – just 1 in 4 people – said they had enough cash to cover three months of expenses, and only 16% said they felt they could cover six months or more of expenses with their current savings.

Now, there are a lot of ways we could go with this conversation from here... But for now, I'll just say as it relates to an investment portfolio, this scenario is less troublesome for high-quality companies that can sell enough products or services to keep margins high in any environment. These are "recession proof" businesses that are likely to weather downturns better than others... like Walmart, which we mentioned above.

All the best,

Corey McLaughlin
Baltimore, Maryland
August 17, 2023