As
we turned the page from July to August, and the technical selling of high yield
bonds slowed and then turned, I started to re-think about fundamentals (and a partially sensational subject line!).
Retail sales was reported on August 13th, and the results showed the
worst month-over-month change in six months (0%). There continues to be a
large disconnect between headline unemployment (which has steadily improved),
and signs of momentum or enthusiasm from the consumer. Without an
incredibly strong consumer, 3rd and 4th quarter growth will not meet the lofty
expectations that have been set.
As
headline unemployment moves its way towards 6%, there has not been meaningful
growth in hours worked or wages earned, two factors incredibly important to a
consumer that is already fragile and doesn't believe that there is minimal
inflation. In the last 10 years, according to the BLS, regular unleaded
gasoline has risen in price by 57%, white bread has risen by 32%, ground chuck
beef has risen by 54%, eggs have risen by 67%, milk has risen by 18% and
electricity has risen by 36%. These price rises in staples pale in
comparison to the nearly 80% rise in the cost of a college education over that
same time period. Compare this with an average annual inflation rate of
less than 2.5%, and it is easy to understand why consumers aren't showing up at
malls, why they will easily and readily seek out discounted prices and why they
have little patience for a less than optimal product or service. The
consumer is tapped out and investor patience is wearing thin...
Disappointing
earnings reports for retailers started on the week of August 11th, with Macy's
and Nordstrom surprising the market. Both are known for their strong
management teams and for their consistent results, but decreased mall traffic,
increased need for promotions, internet competition and tighter margins caught
investors offsides. Guidance wasn't any better, with Macy's CEO Terry
Lundgren warning that, "Many customers still are not feeling comfortable
about spending more in an uncertain economic environment."
Subsequent earnings reports in retailers, with much less respected
management teams and less stellar track records of success, have been almost
uniformly poor. Wal-Mart, a company that is about as close to the average
American consumer as possible, just reported its 8th consecutive quarterly
decline or loss in same store sales.
We
are seeing very poor results and guidance from the companies we are short of.
And while technical selling may have temporarily reversed, with the the
Wall Street Journal reporting earlier this week that "Big investors snap
up junk bonds - Institutions take advantage of a recent slide in high yield
bonds price triggered by small investors selling", the fundamental reality
of the deterioration in credit quality continues. Warning signs are
everywhere, with the most recent being this weekend's interview with TCW in the
Barron's. Tad Rivelle and Laird Landmann, who manage $142 B, point to the
end of the current credit cycle. We agree, and think that technical and
fundamental factors will spur a significant move in high yield over the medium term.
Enjoy
your Sunday,
Richard
Travia
Director of Research
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