☀️☕ “The consumer is still very pressured…”

Happy Wednesday! 🐫

Market Roundup 📊 22-Feb-23

US large-cap S&P 500 closed 2% DOWN 🔻🔻
Tech-heavy Nasdaq Composite closed 2.5% DOWN 🔻🔻
Pan European STOXX Europe 600 closed 0.23% DOWN 🔻
HK’s Hang Seng Index closed 1.71% DOWN 🔻
Japan’s Nikkei 225 closed 0.21% DOWN 🔻

— The MoneyFitt Morning (@MoneyFitt)
Feb 22, 2023

📝 Focus

Consumers under pressure in 2023 (Walmart, Home Depot)

📊 In the Markets

China Tech Stress

Breaking up is hard (for HSBC) to do

📖 MoneyFitt Explains

🎓️ FOMC Minutes

📝 Focus

Consumers under pressure in 2023 (Walmart, Home Depot)

Walmart reported better-than-expected earnings and revenues for its fourth quarter, the three months ending in January. The world’s largest retailer had an outstanding, record-breaking December driven by food sales and steep discounts on excess stock.

Save Money. Live Better. Pay Bigger Dividends… for the 50th consecutive year.
– Image credit: Walmart via Tenor

But underneath those good results were profit margin pressures as consumers spent less on discretionary items (like TVs and washing machines) and more on low-margin necessities (like groceries.) At the same time, it continued to face price hikes from many of its product suppliers in a high-inflation environment, along with the red-hot US labour market starting to feed through into wage costs — Walmart recently announced that it will raise its minimum wage from $12 to $14 an hour to retain store workers. It did benefit, though, from higher-income shoppers now heading to traditionally lower-income destinations like Walmart for discounts amid persistent inflation.

The consumer is still very pressured… if you look at economic indicators, balance sheets are running thinner and savings rates are declining relative to previous periods. And so that’s why we take a pretty cautious outlook on the rest of the year.

John David Rainey, CFO of Walmart

Excess savings from the pandemic are being blown through
– Image credit: St.Louis Fed

As a result, Walmart’s guidance for the year to January 2024 was pretty subdued, with sales growth of 2.5-3% and earnings per share (EPS) between $5.90 and $6.05. The second half of the year is expected to be much weaker than the first. Wall Street’s highly-paid Finest had been expecting a much rosier outlook of 3.3% and an EPS of $6.50.

Home improvement giant Home Depot, the other classic bellwether for US consumers, was even more pessimistic, with its shares dropping 7% overnight. It sees flat sales in 2023 as higher mortgage payments bite and Americans continue to shift their spending towards services instead of goods, particularly those in such demand during the pandemic. Earnings could drop on an incremental US$1 billion it’s spending in wages to hire more frontline staff, depressing profit margins.

Softening demand –mostly seen in goods at this stage– can put a cap on how much companies can continue to hike prices (as they have been doing at will and the expense of consumers throughout 2022), and in the face of higher input prices and wages could weaken corporate earnings more widely going forward.

📊 In the Markets

European stocks were choppy again on interest rate worries and closed only mildly weaker even as US markets returned from the long weekend with a very weak opening.

That weak US opening turned into a relentless slide throughout the day, leading US markets to record the weakest day of the year, while benchmark 10-year US Treasury yields (the interest rate you actually get at a price, and which move opposite to bond prices) hit a fresh three-month high. Walmart’s weak guidance –see above– and Home Depot’s first miss in years added fears of consumer-led weakness to concerns building over the last two weeks that interest rates will indeed be higher-for-longer.

Yes, exactly as JPow and The Fed have been saying for several months — and which highly-paid market experts have been casually dismissing. Minutes from the January Federal Open Market Committee meeting 🎓 will be released on Wednesday and parsed in excruciating detail.

Neel Kashkari said what??
– Image credit: Trailer Park Boys / Netflix via Tenor

Adding to the point on interest rates, two members of the FOMC, Loretta Mester and James Bullard (non-voting in 2023, but still influential), suggested separately that a 0.50% hike at the March meeting may be needed to help tackle inflation. (A week ago, that was a 9% probability, implied by the futures market, right now it’s 24%.) And if you think today’s selling based on this is a bit inconsistent with today’s fears about weak consumer demand, 1) trust your instincts and 2) welcome to the market.

Credit Suisse fell over 8% to new lows on a Reuters report that chairman Axel Lehmann’s early December comments that outflows had stabilised were being reviewed by Finma, the Swiss financial regulator, for potentially being misleading. Outflows had “completely flattened out and… partially reversed”, he’d told the FT. In fact, outflows continued throughout December and into January across the group, as revealed in its full-year results earlier this month.

China Tech Stress

Earlier on, out in HK, markets had already tanked on reports that internet giants would be intensifying competition to win market share, thereby destroying everyone’s margins. JD.com (9618 in HK, JD on NASDAQ) dropped 8.5% in HK and 11% in later US trading on its plans for a subsidy campaign of RMB10 billion (US$1.45 billion) to compete with rivals like US-listed Pinduoduo (PDD) which fell 9.5%.

Just a click away from your sofa
– Image credit: Mulan Sukrisno

Then food delivery giant Meituan (3690 in HK) dropped 4% on plans to expand into HK and to hire 10,000 people to compete at home with Alibaba-backed Ele.me and new players like Bytedance in China. (Yes, Bytedance, the parent of TikTok, which has started using its Chinese twin Douyin to test food delivery services based onese megacities. Expect TikTok to do the same elsewhere if it’s successful.) Alibaba (9988 / BABA) and Tencent (0700) both also lost about 4%, dragging the Hang Seng Tech Index down 3.6% by the close. The various initiatives follow Beijing’s recent apparent easing of restrictions on the sector’s influence — good for growth, but markets are now worrying about profitability.

And alongside reports of Chinese ports clogged with empty shipping containers, suggesting weakness in export demand, Korean and Taiwanese export data hint that some of the slowdown seen earlier in their exports may be easing. European demand seems intact, while the US shift away from durable goods continues (see Focus.)

Breaking up is hard (for HSBC) to do

HSBC, once the largest bank in the world (well, in 1934) and still the seventh biggest by market cap (share price X number of shares) and Europe’s largest by assets, reported pre-tax profits that almost doubled to US$5.2 billion in the fourth quarter of last year alone, beating the best guesses of The City’s Finest by 5% as higher global interest rates boosted revenues. Net interest income –what banks make from borrowers less what gets paid to depositors– rose 53% to $9.6bn.

“Why are you so quick to put up our mortgage rates and… so slow to pass on the effects of increased interest rates to our savings accounts? Particularly since borrowers are having difficulty meeting interest repayments at a time of high inflation and squeeze on living standards.”

Sir Philip Augar, an independent banking expert, on BBC Radio.

But the company’s conservative forecast for earnings suggests that the tailwind from charging higher interest rates to its borrowers while passing on peanuts to its long-suffering depositors around the world may have peaked.

In general, the flip side of higher interest rates for banks is in potential losses on the loan book from under-pressure borrowers. In HSBC’s case, that came through in US$1.4 billion in credit losses and impairment charges for the final three months of the year, up from $500mn a year earlier (though $600mn of those provisions were on potential losses on its troubled $16.8bn mainland China commercial real estate book.)

To fend off demands from Chinese insurance giant Ping An (its largest shareholder with just over 8% of the company) to sell off its non-Asian businesses, it raised its dividend to the highest level in four years and said it might make a special payout next year while considering share buybacks sooner than expected. The effect on management of an activist investor, again. But in this case, Ping An’s demands came in response to the ban by UK regulators on HSBC from paying anything in dividends in 2020, during the early days of the pandemic. It has since been restored but at a much lower level. Though 78% of earnings came from Asia (60% excluding a loss from selling businesses in France), the bank insists that a global footprint remains essential and a breakup would be complicated and “would not deliver increased value for shareholders.”

🎓️ Mini-Explainer: The Interest Rate Trade-off for Banks

There is a trade-off for commercial banks when interest rates go up. The effect can be bad for them because

The positive side, however, is on pricing:

New loans can fall (higher interest rates mean a higher cost for borrowers)

An economic slowdown can lead to losses from some existing borrowers, with more unable to make either interest payments or repay the principal borrowed. Banks will also usually deduct “provisions” against future loan losses from their revenues.

Fees, including those on investment banking deals (if any), also tend to be lower in a slowing economy.

The positive side, however, is on pricing:

Spreads, the interest rate it lends at (in loans to customers) vs the amount it borrows at (from its depositors), tend to be wider. This increases net interest margins and, therefore, net interest revenue, the difference in dollar terms between how much a bank earns on its loan book and what it pays out for deposits.

When rates go down, banks benefit because more deposits are short-term and go down quickly, compared to loans which take longer to change their rates. But when rates go up, banks can often take their own sweet time to raise deposit rates, so they don’t lag the higher loan rates by much, if at all. (Especially large banks with deposit franchises).

📖 MoneyFitt Explains

🎓️ Fed’s FOMC Minutes

Eight times a year, the Federal Open Markets Committee (FOMC) of the US central bank, the Federal Reserve System, meets and sets interest rates for the country. Three weeks after the day of the decision, the minutes of the meetings leading up to it get released. Marketwatchers really care about the minutes, even with the next FOMC meeting three to five weeks later!

The Fed will either do nothing, raise or cut US Dollar interest rates by a certain amount (usually in multiples of 25 “bps” or basis points, which are 0.0001%, and which are called “beeps” in the market.)

The mandate of the Fed is 1) to maintain price stability (at 2%, not 0.0% inflation) and 2) to ensure “maximum employment” – not zero unemployment, but the highest level of employment that the economy can sustain over time.

Generally, if the Fed “tightens” monetary policy (hikes rates) more than expected, the market will react negatively, and vice versa. If it “loosens” policy (cuts rates) more than expected, markets usually rally. (And not just in the USA!)

But what the minutes of the FOMC meetings will reveal is the reasoning of the Fed and the individual committee members in greater detail, and more importantly, offers clues about their longer-term views, intentions and biases. It also offers their perspective on the state of the overall US economy and the overall Fed balance sheet, so you can see why many investors eagerly follow what the minutes say in minute detail!

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