Stocks Fall - Extend Losing Streak

The stock market sold off for the 4th straight time on Thursday. S&P 500 fell 0.81%, Nasdaq fell 1.13%, and Russell 2000 fell 0.86%. Personally, I find the headline that the stock market fell on fears of an economic slowdown humorous. 

There were plenty of bad economic reports in January and February, yet stocks rallied. The concept of a slowdown has been apparent in economic reports for the past 6 months. ECRI leading index’s yearly growth has been negative for a few months.

The slowdown isn’t new; the economic surprise index has been negative for a couple of weeks. What’s new is stocks being very overbought. They overcorrected to the sharp decline last year which was itself an overreaction. 

Stocks Fall - Stocks should be below the September record high until the slowdown ends.

Stocks got less overbought with the decline on Thursday as the VIX increased 5.4% and the CNN fear and greed index fell 4 points to 59 which still signals greed. I’m not bullish yet as the S&P 500 is only down slightly less than 2% since Friday’s close. However, I am much less bearish now. 

The only positive sector was utilities on Thursday as it increased 0.26%. Worst 2 sectors were financials and consumer discretionary which fell 1.06% and 1.37%. It was a broad-based decline.

Treasury yields continued to plummet on Thursday as the 10-year yield fell 4 basis points to 2.64% (it’s now at 2.63%) and the 2-year yield fell 5 basis points to 2.47%. The bond market clearly believes the economy is slowing and inflation will be weak. Now the 2-year yield is only 7 basis points higher than the Fed funds rate and 9 basis points above its year to date low (the lowest yield since May 2018).   

Stocks Fall - Costco Reports Great Earnings

Costco is the first S&P 500 firm to report earnings. The bulk of earnings season starts in 2 months. However, it’s interesting to see how this important retailer did to see if the consumer is still spending. Costco is the 4th biggest retailer based on 2017 sales, which means it is a solid indicator of the health of the consumer.

The firm beat EPS estimates as they came in at $2.01 which was more than the consensus of $1.69. EPS was $1.59 last year. Revenue was up 7% to $35.4 billion which missed estimates of $35.67 billion. Margins were helped by lower gas prices. Gross margins increased 31 basis points to 11.29%. 

That explains the big earnings beat amidst the minor revenue miss.

Costco announced it will raise starting wages to $15 and $15.5 an hour in America and Canada which is up from $14 and $14.5 an hour. This supports the notion that the labor market is very tight and that low wage workers are seeing the biggest benefits. 

While wage growth isn’t catalyzing inflation, it will lower profit margins. These wage hikes along with the hikes for supervisors will add 3-4 basis points to selling, general, and administrative expenses over the next 4 quarters.   

Costco was helped by its shift to lower cost sourcing. Pricing pressures fell in its groceries business which means food inflation could increase and margins will be helped. To be clear, from Costco’s standpoint, pricing pressure means competitors are cutting prices. The firm is investing in its stores, online, and delivery options. 

Instacart offers same day delivery. Its website improvements helped online sales increase by 25.5%. These great results caused the stock to rise by 4.71% after hours on Thursday.

Stocks Fall - Big Boost In Job Cuts

Total announced layoffs as measured by the Challenger Job-Cut report showed cuts increased from 52,988 to 76,835. Job cuts hit a 3 year high. Layoffs can take months to occur, so this is a leading indicator for jobless claims and the monthly BLS report. 

The labor market could weaken in Q2. However, this isn’t a recession warning as cuts were higher in 2015. Monthly average in Q1 is 64,912 which is above the Q4 monthly average of 57,534. Averages were 40,293 and 34,933 in Q3 and Q2. That’s 3 straight quarters of increases unless the number of cuts crashes in March.

According to this report, the economic slowdown is picking up steam. 

Each report is volatile, so the quarter average gives us a reading with less noise. Industrial goods had the highest layoffs in February at 29,665. Retail is 2nd at 18,874 and 22,237 in the past 2 months. That’s because many physical stores like Payless are being closed. Even Amazon announced it is closing all 87 of its pop up kiosks. No specific companies were mentioned in this report as catalysts for this increase.

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Stocks Fall - Strong Productivity Growth

Productivity growth has been weak in this expansion even though there has been heavy private investment into research and development. 

Q4 results beat estimates as quarter over quarter growth was 1.9% instead of 1.6%. Unit labor costs were up 2% which beat estimates for 1.8%. Output was up 3.1% and hours worked were up 1.2% which signals more was produced in less time. Compensation was up 3.9%. Real compensation was up 2.4% which is up from 1.4% in Q3. This supports my narrative that we are seeing accelerating real wage growth. 

It’s hard for the economy to have weak GDP growth when workers are getting real pay raises.

The situation isn’t as great for employers as compensation was above output growth. That’s looking at it on a quarter over quarter basis. The results are the opposite on a year over year basis as productivity was up 1.8% and unit labor costs were only up 1%.   

Stocks Fall - Conclusion

Stocks are on a 4-day losing streak, but they haven’t fallen enough for to me switch to being bullish. The goods news is Costco’s great results show us the labor market is catalyzing wage growth. 

The bad news is the Challenger Job-Cut report suggests the labor market might weaken in the next few months. That’s an example of a leading indicator showing trouble is ahead.