Morning Briefing | The Economy's 'Mixed Bag' Outlook
Toll Brothers capitalizes on low housing inventory – Luxury homebuilder Toll Brothers (TOL) posted better-than-expected revenue and earnings for the quarter, driven by an increase in home deliveries and surging demand. The market's historically low supply of existing homes has fueled demand for new construction, pushing Toll Brothers' contracts for the quarter up 77% from the year prior. CEO Douglas Yearley said that the current supply shortage will likely continue for some time and that it should add to the long-term tailwinds already supporting the industry.
Foot Locker feels the brunt of inflation – Foot Locker (FL) reported a continued decline in sales in the second quarter, causing it to cut its forward-looking guidance for the second time this year. The company blames growing consumer "softness," claiming that folks can no longer withstand the pressures of high inflation. The retailer reported a $5 million loss for the quarter compared with $94 million in profits a year ago. Foot Locker CEO Mary Dillon said the company will adjust its outlook accordingly to "best compete for price-sensitive consumers" moving forward.
Fed's Barkin favors firm rate target – Economists have recently called for the Federal Reserve to consider upping its 2% inflation target. Richmond Fed President Thomas Barkin countered this idea, saying that the central bank could lose credibility if it were to consider changing the target before achieving its goal. He emphasized that 2% inflation is not an unattainable figure and that the Fed shouldn't deviate from its target prematurely. Barkin also believes the U.S. economy could experience a "soft landing" and a mild recession as long as key data remains strong.
Housing headwinds weigh on existing-home sales – Sales of previously owned homes in the U.S. declined in July, reaching their lowest level since the start of the year. Short supply and higher borrowing costs dragged sales down more than 18% year over year. Contract closings fell 2.2% from the previous month, nearing the slowest rate since 2010. High mortgage rates and inventory woes are pushing potential homebuyers toward new construction – and even complete withdrawal from the market.
Bank shares slide amid more credit downgrades – The stocks of five regional banks plunged earlier this week after S&P Global downgraded their credit ratings. Associated Banc-Corp (ASB), Valley National Bancorp (VLY), UMB Financial (UMBF), Comerica (CMA), and KeyCorp (KEY) all had their ratings cut due to a number of risks identified by S&P. While they weren't explicitly mentioned, this weighed on several large banks, such as JPMorgan Chase (JPM) and Bank of America (BAC). The downgrades don't pose an immediate systemic risk, but they highlight problems plaguing the sector – namely regional lenders weakened by higher interest rates and those with heavy exposure to commercial real estate.
The U.K.'s private sector is losing steam – Private sector firms in the U.K. recorded a surprise contraction in August, the first in seven months. S&P Global's Purchasing Managers' Index slid to a score of 47.9, which marked the lowest level in 31 months. (A score below 50 indicates a contraction.) Economists had expected a mild contraction, though a score above 50. Companies blamed high interest rates and pricing pressures, saying they've had a stranglehold on manufacturing production this year. Martin Beck, chief economic adviser to the EY Item Club, was one of many analysts to suggest the recent economic data should give the Bank of England a reason to pause rate hikes in September.
Wall Street's predictions are all over the place today...
Some analysts project a looming recession. Some deny we'll see one at all. Others go back and forth speculating about the potential severity or mildness of a recession. And many have reversed their calls altogether.
The Federal Reserve, remarkably, has also altered its stance. The central bank economists that called for a recession back in May and June now no longer see one on the horizon.
Morgan Stanley's equity strategist Mike Wilson even walked back his pessimistic calls. For most of the year, Wall Street's "biggest bear" warned of an earnings recession. Wilson said that the market's rally would come to a screeching halt... and that equity valuations would come back down to Earth. Then, in a note to clients late last month, he said, "We were wrong."
To put it plainly, we're dealing with a mixed bag of economic and market expectations.
Investors are eager to know when they'll see some semblance of certainty. And while folks seem more optimistic about the economic picture today... the data continues to tell another story.
According to the latest National Federation of Independent Business ("NFIB") banking survey, 58% of small businesses believe the state of the U.S. economy is "poor." Only 32% said that it was "okay." In other words, nine in 10 small businesses believe things could be better.
To make matters worse, more than half of small businesses believe we're currently in a recession.
On a positive note, only 30% of small business owners reported that the financial state of their business was "poor" or "okay." So it seems small businesses (much like the consumer) are doing what they can to make ends meet.
In fact, according to the survey, 21% of businesses applied for a bank loan or line of credit in the last three months.
Overall, the NFIB's Small Business Optimism Index has been pretty flat for the better part of this year. Take a look...
July's reading of 91.9 marked the 19th consecutive month below the 49-year average of 98. This tells us that things in general aren't great for small businesses... but that it's also not all doom and gloom.
Big-box retailers aren't fairing much better. Recent reports actually tell us things may be worse...
Retailers handed investors a mixed bag of results for the second quarter. Several big-name companies came in topping analyst expectations, but things mostly seem to be down across the board.
Retailers are struggling with consumers opting for lower-priced essentials and dialing back on larger non-discretionary purchases such as toys, clothes, and appliances.
And Macy's (M), Dick's Sporting Goods (DKS), Lowe's (LOW), and Home Depot (HD) have all sounded alarm bells about the future outlook of consumer spending.
Macy's CEO Jeff Gennette noted that the retailer is seeing increased credit-card usage and that many consumers have opted to spend on experiences rather than goods.
Dick's Sporting Goods CEO Lauren Hobart highlighted the challenges the company has recently faced with retail theft. The company blamed "organized retail crime" for a 23% drop in profits. And Hobart said that theft is an increasingly serious issue for the entire industry.
Home-improvement retailers Lowe's and Home Depot both expect their full-year results to be down from last year, largely due to a decrease in do-it-yourself ("DIY") shoppers.
However, they mentioned that professional home-improvement shoppers have been able to buoy sales and lessen the loss of DIY shoppers thanks to the ongoing shortage of existing homes and sky-high home prices.
That brings me to my next point...
According to the National Association of Realtors, existing-home sales fell to the lowest level since the start of the year in July. It's clear that diminished inventory levels continue to have a stranglehold on the housing market.
As you can see, existing-home sales fell 2.2% month over month to an annualized rate of 4.07 million units. Year over year, the number is down 16.6%...
On a seasonally adjusted basis, that is the slowest annualized pace of sales for July since 2010.
All these recent economic reports seem to be telling us the same thing: The economy is hurting.
But as our colleague Corey McLaughlin explained in a Digest earlier this month, these times won't last indefinitely...
There are always risks out there that could upend the status quo. A rebound in inflation (quite possibly with energy prices moving the way they are) could move interest-rate expectations higher again, hurting stocks.
Alternatively, a dose of deflation in specific industries or broadly, like what's happening in China now, could change the game. So could mounting job losses. A credit crisis is possibly ahead, too. Any or all of those situations would likely push the Fed to cut rates because the economy will need a boost.
The best course of action for investors is to worry less about the onslaught of diverging opinions from media pundits and economists... and instead on positioning yourself to weather the uncertainty.
As I've said time and again, it's extremely important to manage your risk – especially in the event this economic downturn starts to send the market tumbling.
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