Conflicting Data in a Market Lacking Conviction

We’ll kick off today’s slightly delayed newsletter by highlighting the most important events of last week and placing them in the context of various asset class markets.

The key event happened on Friday, as the PCE inflation report was released. Fortunately for Jerome Powell & Co., this report was weaker than expected, with the headline PCE price index at +0.0% versus expectations of a 0.1% increase and the Core PCE at +0.1%, a tenth below projections. We now have more solid evidence that inflation is continuing to decelerate, after a 6-month stall.

A subset of the PCE reading (called Supercore PCE) gained popularity recently due to it being mentioned in numerous Fed press releases. These prices account for almost half of the PCE and include labor-intensive core services, but exclude housing. As such, similar to the Sticky Price Index, Supercore PCE is a decent indicator of tightness in the labor markets, which can impact wages and, ultimately, inflation.

The breakdown of Supercore PCE (courtesy of Zerohedge) shows that 5 out of 8 components are currently negative, with only healthcare and food service/accommodations remaining positive. If it wasn’t for health insurance, this measure would be negative today. Also, note that the spike in January was not in fact a “trend reversal” in inflation readings, but a one-time phenomenon (which can happen within any given dataset).

So is this good news for the markets? Well, it depends who you’re asking.

For retail giant Nike (NKE), weakening personal consumption spells trouble ahead. On Thursday night, Nike disclosed the latest financial results, which came in 0.17 above expectations in terms of EPS, but missed revenue forecasts by $250 million. Furthermore, their guidance for fiscal 2025 was terrible, pointing to contracting sales. Nike can no longer hike prices to keep up with inflation, indicating that the consumer is becoming more frugal. Weakness in China as well as competition from other “lifestyle brands” are also pressuring the top and bottom lines. Per the CEO:

“There was a shift in our lifestyle brands that caught us by surprise, and without new products, we’ve had less interest. Newness is driving the consumer and we’ve got to move to more newness. We are also chasing our competition in women’s apparel and running. We said last quarter we had a new playbook that will start our comeback with new innovations. We aren’t there yet, and our numbers are going to be worse in 2025 than we previously thought.”

Conclusion: RIP NKE stock, now -57% from ATH.

Another retailer is facing large difficulties, namely the pharmacy chain giant Walgreens Boots Alliance (WBA). The company announced the closure of 25% of their 8600 stores over the next 3 years, a decrease of 57K in headcount and lowered EPS guidance from $3.20-$3.35 to $2.80-$2.95. The CEO’s comment stood out:

“We assumed the consumer would get somewhat stronger,” but “that is not the case,”

The stock market’s reaction was similarly brutal for WBA:

Unsurprisingly, on a relative-to-SPY basis, the Consumer Discretionary Sector ETF (XLY) is sitting near 2-year lows.

The latest Consumer Confidence survey from the Conference Board is reflecting the issues that all B2C companies are facing. Put simply, the consumer is under pressure, with a deterioration in confidence clearly showing up in corporate financials. Sharp downturns in this index have usually preceded more pronounced economic slowdowns and recessions.

We should expect a decent correlation between confidence and financial asset markets. After all, consumption makes up roughly 70% of the US economy and provides corporations with revenue and earnings. The change in sales and EPS is the primary driver of price movement in individual stocks. Logically, the change in confidence should lead developments in the stock market.

But that’s not exactly the case at the moment. While confidence in the economy may be more or less constructive, there is one area where consumers are highly optimistic: the market itself. First of all, the perceived threat of a recession in the next year is waning:

The AAII Bull / Bear spread is also reasonably elevated, with optimistic sentiment also on the high side. The New York Fed also recently noted the following:

The New York Fed’s latest consumer survey found that expectations that stocks will be higher in the next 12 months rose from 39% to 41% since last month’s reading. At the same time, inflation expectations dropped slightly. Consumer sentiment numbers have recently highlighted how certain demographics are thriving while others aren’t, but with the market near all-time highs, it’s no surprise that those who own stocks are feeling good.” 

From our perspective, being bullish on the market, but not particularly confident in your own finances doesn’t make a lot of sense, but this is where we are right now. It’s likely that the Fed’s repeated interventions and stimulus measures have dulled the perception of risk on the part of retail investors. After all, if the Fed has proved it will backstop any significant market decline, why bother selling?

Certainly, we can attest to this kind of complacency in today’s market, where SPY has been advancing gradually with minimal losses in 2024. On a risk-reward basis when viewed on our adjusted chart, the benchmark ETF is getting expensive, climbing near the top of the trading channel. Support levels are rising (R1 is now above the last close), and it will be more and more difficult to maintain momentum going forward. We believe that in the following couple of months, there will be a better opportunity that we can use to “buy the dip”.

July is historically a positive month for stock returns, especially in the last 10 years. So the decline we are expecting is more likely to occur in the August - October period, as election anxiety sets in.

Our Trading Strategy

The bullish trend is firmly intact but the market is overbought on many measures. Upside appears limited at the moment, but the market did nothing “wrong” and getting too defensive is unwarranted. Maintaining a balanced allocation is probably the best choice when it comes to portfolio management going forward.

This is a holiday shortened week, but there will be plenty of economic data for investors to digest. The ISM manufacturing survey will be released on Monday, and the services survey will be released on Wednesday. Employment data, including JOLTs on Tuesday, ADP on Wednesday, and the BLS employment report on Friday, will be the key data points of the week.

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