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Episode 3: How to play the U.S. CPI and Walmart and play Ford's stick against U.S retail sales

Episode 3 - Part 1

How to play the U.S. CPI and Walmart and what the data means to fears of recession

Published on: November 12th, 2019 • Duration: 7 minutes

In this inaugural episode, we look at the Fed rate announcement and the Apple earnings report.

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  • [00:00:04] It's Tuesday, November the 12th. I'm Jamie Macdonald and this is Before and After from Refinitiv. This week in the before segment of the show, we're looking at how to play the upcoming US CPI and Walmart's earnings call in the after segment. We look back at what we can learn from the Japanese machine orders report. Let's jump right in. With markets fixated on deflation and disinflation, there are so many data points to study; factory inflation, employment costs and average hourly earnings just to name a few, but it is US CPI that households really care about. The Consumer Price Index imagines a basket of hypothetical goods and services. It arrives at a weighted average of the price changes. Worldwide many of the inflation indicators are trending down. Some indicators, such as PPI, are falling below zero in areas such as China and Europe. Long term inflation expectations may have bounced, but nowhere near enough to move them from their all time lows. US core CPI, however, is at the six year highs of 2.4%. An unexpected move higher could fuel yet another jump in risk assets as the market is forced to reprice for growth. The markets appear to have been caught short by the reflation talk over the last few weeks, with bond yields rising and equity markets surging. Jerome Powell said explicitly that inflation would have to rise before the Fed takes notice. Quoting him from the last Fed meeting, "I think we would need to see a really significant move up in inflation that's persistent before we even consider raising rates to address inflation concerns". It looks like even if core CPI breaks above the six year highs, the Fed is not going to flinch. They're going to let inflation run hot. If the markets sense that happening, we may have only seen the start of the shift to repricing for growth. On the other hand, this may dial back some expectation of central bank liquidity that this move in risk pricing has already implied. The equity markets may opt for a breather. They may have to temporarily set aside their love of liquidity because while the Fed will not act to stop inflation, they will also not be in any hurry to cut rates again anytime soon. If core CPI misses, well, then the broader concerns from earlier this year were not misplaced and will again be relying on the kindness of central bank liquidity. In terms of price action, our definitive data show us that we should keep an eye on how the iShare bond fund ETF trades. The fund tracks the performance of Treasury Inflation Protection Securities, commonly known as TIPS. So a big bump up in CPI would result in a higher tip price while other bond prices should be tumbling. An upside surprise in inflation would catch the market off guard, to say the least, but US core CPI is primed to catch investors on the wrong side. The other big upcoming announcement we want to look at this week is Walmart. Before the Internet, people used to go to a store and buy things. In this before segment, we have the brick and mortar behemoth that refuses to back down to the online onslaught. With its share price near all time highs, giving it a market cap in excess of three hundred billion dollars and a nosebleed PE of over 24 that you would commonly associate with a cyclical or tech stock rather than a grocery store, Walmart's daily volume average is in excess of 700 million dollars and has a historical volatility that is close to 10. Because of all these factors, results day can be a great trading setup for both institutional and day traders alike. You could perhaps make the argument that it is just the usual suspects of cheap capital on the hunt for reliable revenue and dividends who are willing to pay a premium that keeps driving Wal-Mart's share price higher. But this earnings reports will be the real test. Wal-Mart's PE is extremely stretched as the stock has rallied hard with no earnings growth and flatlined revenues. The last time Wal-Mart's PE was above 24, a 25% correction ensued in the following six months. That should sound some alarms at 24.43 PE  Walmart is one of these priced to perfection names. It leaves little room for error and they can't afford a hiccup in operating costs. If revenue guidance comes out weaker than expected then look out. Walmart is expected to earn $1.10 a share and all eyes will be on whether they can maintain that e-commerce yearly growth of 35 percent. They have to take on Amazon at Amazon's game, focusing on the same one day fulfillment initiative that Amazon has invested so heavily in. With the announcement of their earnings there are more scenarios pointing towards the stock, taking a breather on the downside than having a surge higher. If Wal-Mart doesn't show store growth of three point five percent and we see operating margins continue to squeeze perhaps due to trade wars, we should see some selling. Unless guidance is dampened greatly, the external factors that have guided Walmart stock higher would remain in place. Our Refinitiv chart highlights the blinking warning light that the market is entering a near parabolic regime here at the end of the year. A mediocre result with bullish price action would be a very strong confirmation that the year end flow is real and the so-called Santa rally is in the cards for the markets. Remember, this stock is one of the poster children for passive money. It will take a lot more than an earnings miss to turn those inflows around. Last episode we discussed Japan and their role at the epicenter of the global manufacturing slowdown because of their industrial core and proximity to China. The previous revised reading for Japan's machinery orders fell to minus fourteen point five percent, the lowest level since 2014, and was one of the data points hinting that a global manufacturing recession may be upon us. This month's release was therefore going to be a barometer not only for Japan, but the broader global manufacturing outlook. Well, the year on year figure had a healthy rebound to 5.1%, right back into the middle of the longer term range. Not only is it a relief that Japan's manufacturing sector is not undergoing a massive deceleration, but it joins numerous other global data points, such as US non-manufacturing ISM and the export components of the ISM manufacturing data in having a significant rebound from the previous month's release. Many of the concerns around a global recession will now be on the backburner, and the relief rally that we've seen in global markets over the last couple of months can remain on track. If there is any downside, it's that strong data will temper some of the optimism for more central bank accommodation. Though this data set in isolation is not going to stop the Bank of Japan in its tracks. There you have it. Walmart earnings and US core CPI for the before Japan's machine orders rebound for the after. I'm Jamie Macdonald. This was Before and After. I am back on Friday. See you then. 

Episode 3 - Part 2

How to play Ford against U.S. retail sales and what CPI data could mean for interest rates

Published on: November 15th, 2019 • Duration: 5 minutes

This week, we examine the U.S. retail sales report and what its potential impact could be on Ford. Additionally, we take a deep dive into home builder confidence and core CPI to see what it could mean for the bond market and monetary policy moving forward.

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  • [00:00:04] As investors, we all know that we can make big profits or losses around major economic or corporate data releases. In this show, we're going to discuss which of those could move markets in a meaningful way and then address how to play them. The show is going to be in two parts. We have the before part, which is going to look at what's coming up, expectations going into that event and the different ways which results can move asset prices. And then we've got the after portion where we look back at what actually happened, how it affected prices, and then learn from that price action for future trading. You see what we're going for here? Great. This week, you might think we're going to focus on Apple's earnings results coming out. Not this week. We think there's something much more important than that to focus on. This week could see an event that could dictate asset performance for the rest of the year. On Wednesday, the FOMC, that's the Federal Open Market Committee, also known as the Fed, will make their decision on interest rates. Why is this so seismic? It's because the Fed has effectively been propping up the world economy for the last decade and keeping interest and therefore borrowing rates low. How do we get to this? No surprise it all started in 2008. Not many of us are going to forget the economy in 2008, which was having a massive heart attack. So the Fed had to do something drastic to assure basic things like banks had enough cash to cover deposits. Their solution was to set interest rates at zero to try and support the economy. But that wasn't enough. When the crisis started spiraling out of control, they entered the bond market as a buyer and for some time they were the only buyer. It's this process that's called quantitative easing, but luckily it worked. It helped stop the carnage of what was a real financial panic by showing investors that the government would always do something to save bank deposits. Over the course of the next nine years. The Fed kept printing cheap money. In fact, its balance sheet reached 4.5 trillion U.S. dollars. By doing this Central banks distorted the natural order of markets, and the world has become dependent upon a constant flow of cheap money. And it meant that the US economy picked up. So after a while, the Fed tried to get things back to normal by raising interest rates and unwinding the now inflated balance sheet. This is called quantitative tightening. It was going well until the equities market skidded in the fourth quarter of 2018. It spooked the Fed, who then decided to put the brakes on quantitative tightening and interest rate hikes. So where are we now and why is Wednesday's announcement so important? Well, Jerome Powell, who is at the helm of the US Fed, is tasked with the unenviable burden of balancing a US economy that's sending mixed signals. We have the weakest ISM manufacturing data in over 10 years, but we have an employment picture that remains firm and a US consumer that's unfazed. And that's not all. He's under political pressure from President Trump to cut rates as the US is heading into an election year. What could they announce and how could it impact the market for investors? Well, firstly, we could see no change to rates. Secondly, a 25 basis point cut. Thirdly, a 50 basis point cut. The market recently placed a 90 per cent probability that the Fed will cut the benchmark interest rate by one quarter of a percentage point. At this October meeting, the Fed has never failed to deliver when market expectations have been that high. So what happens if they deliver on the quarter point cut? Given that the market is 90 percent sure that there's quarter point cut is going to happen, it's fair to assume that it's already priced into people's expectations. Of course, it also means that were it not to happen, the reaction would be sizable. The expected 25 basis point cut means the dollar should return towards the middle of its range. Bonds should edge lower and yields edge higher. Equities, well, they're going to struggle to push on because they're already near their all time highs. But and it's an important but, The market may be more confident than the Fed, and the Fed itself hasn't been as predictable as it has been in the past. At the start of the year, the Fed was making decisions that were unanimous, but by the September meeting, the committee was split seven to three. So what would happen if the Fed failed to deliver on the quarter point rate cut that everyone expects and instead made no cut at all? Now, that would be interesting. Number one equities will sell off hard and fast. And the biggest down day of 2019, which was down 3 percent,  well, that could be eclipsed. Number two, treasuries. They'll also sell off. And remember, the US 10 year yield is within striking distance of that crucial 2 percent level. And thirdly, the dollar would probably explode to the upside, causing huge pain in emerging markets and all the commodities such as oil and copper. They'll dislike a strong U.S. currency. And then there's another twist in the tale. What if they shock the market and not only held interest rates at the same level for now, but indicate that they're actually planning to move them up in the future? Stocks would plummet and yields because there would be a fear of global economic slowdown. Luckily, this is very, very unlikely. All right. What if they went the other way and they cut by half a percentage point instead of the quarter that everyone else is expecting? Well, this really would be a shock. In fact, the market has given it a zero probability. What else should we be looking for? The Fed will also release an accompanying statement which economists will pore over for signs of life. The Fed may use this to signal that the cut they've made is the last one for a while. It'll probably be described as the completion of the mid cycle adjustment and it could be the pin that pops the equity balloon. No more cuts to come for a while is negative for equities, especially with expectations where they are. Alternatively, if the Fed sees no inflation and healthy asset prices rather than bubbles, then the equity party carries on. And talking of parties, if the Fed sees global manufacturing weakness  taking a sharp drop lower and suggests they're ready to cut interest rates a lot more in the future than the equity fears that will rage on because equities love cheap money more than they love growth. OK. A lot of scenarios here. So what's the bottom line? Right now, equity markets worldwide are a bit stretched to the upside. The risk is that people are so expectant of a quarter percentage rate cut that if it happens, there'll be an anticlimax. And stocks will drop off their highs. Having said that, remember, the Fed will always have your back. We can't forget about Apple entirely. And the reason we must focus on Apple is that large tech is having some big moves. Just last week, another tech juggernaut, Amazon, reported slightly worse results. And the stock got taken to the cleaners, down 9 percent in the aftermarket. And then it opened up another 6 percent down the next day. Why does this matter for Apple? Well, it shows that stocks, especially tech stocks, are priced to absolute perfection. Any hiccup at all could lead to some short term profit taking. So what should we be looking for? The key metric we need to focus on is iPhone shipments. The number the street wants to see is forty two point three million. A miss on shipments and the stock could pull back to the twenty three point six Fibonacci retracement level at two hundred twenty six dollars and 90 cents a share. And that wouldn't be unreasonable in short term profit taking roughly a 7 percent sell off. Well, that's kind of like Amazon. Remember, the FOMC is earlier that day and so it will be Jerome Powell and his pals in the Fed that are going to dictate the market. I'm Jamie Macdonald. Thanks for watching. Before and after. And I'll see you again on Friday