For those of you looking for a Santa Claus rally, don’t hold your breath. While we are not discounting the possibility the outlook is not promising what with the dark specter of inflation and COVID-19 still plaguing the market. This week, inflation came into full focus with both a hotter than expected PPI figure and a shift in FOMC policy but we fear the committee is still far, far behind the curve. The FOMC indicated they would double the pace of the taper, ending it in March, but gave no indication of when the first interest rate hike would come. Despite that, the committee also indicated there would be as many as three rate hikes by the end of the year. This news is nothing more than the market was expecting and, based on the data, we expect to see the timeline moved forward again. There is no sign that inflation is slowing and every reason to think it will continue on at a high single-digit pace until …. the FOMC is able to get it under control. The risk is that, with inflation still accelerating, the consumer level impact will exceed 10% very, very soon. Regardless, if the Fed waits until May or June like they are hinting we’ll have had more than 12 months of high inflation putting the YOY gains in the mid to high teens. What does inflation mean for the economy? It means a constriction of activity because consumers will have less “disposable” income and that is already being seen in the data. This is not the first time we’ve pointed this out but inflation is outpacing retail sales by a very wide margin. This month, retail sales came in at only 0.3% YOY compared to the 6.8% increase in CPI. This means that, at face value, the volume of retail sales is really down 6.5% with the difference made up by higher prices. The higher the prices go the bigger the impact on volume. This situation is not sustainable but may continue for the foreseeable future. Wages are still rising as well, underpinning inflation, and we haven’t yet reached a point where businesses start saying “no more”. At least not that we’ve seen, anyway, but it’s sure to come. Until then the S&P 500 (NYSEARCA: SPY) will likely maintain its uptrend if one is punctuated by rising volatility and periodic minor corrections. This is a sign of rotation within the index as investors move out of the poor performers and into the more resilient names. The real risk right now is COVID-19. That pesky little bugger won’t go away and now, with Omicron threatening to disrupt supply chains even further, the market may be facing a revaluation. Not only is the S&P 500 trading near historically high valuations and 67% above its long-term trend line but there is also a rapidly declining pace of growth to be concerned about. If we add the additional weight of downward revisions and/or weaker than expected results the market is sure to fall. The good news is that fundamental conditions are still good even if the market is overpriced. A correction of 10% or 20% would get the market back into a more reasonable price range and likely spur institutional buying and share repurchases. If the market should fall this week, don’t read too much into the move because it is a holiday week. The market will be closed on Friday in observance of Christmas and trading volume is likely to be light. This Is What To Expect In The Week To Come A Very Busy Week Of Economic Data The end of the month is near which means there is a lot of economic data coming out this week. The week is shortened by a day due to holiday which means the load of data is being squashed into four days with the bulk due out on Wednesday and Thursday. Last week, the data was fairly mixed as it has been of late. The bulk of the data is positive but much of it came in weaker than expected. The takeaway is that economic activity continues to expand if in a spotty fashion with the obvious impacts of inflation, labor shortages, and supply chain headwinds not too hard to find. This week starts out with a reading of the Index of Leading Indicators on Monday and ends with Consumer Sentiment on Thursday. In between are readings on GDP, Existing and New Home Sales, and the monthly Income and Spending figures. The income and spending figures include the PCE price index, an index we expect to see accelerate for the 10th consecutive month. Last month, the index came in at 5.0% headline and 4.1% at the core, this month we’re expecting consumer-level inflation to run above 6.0%. Next week’s calendar will probably be light. The month ends on Friday, January 1st is on Saturday, so the NFP and labor data will probably come out the following week. A Slow Week For Earnings The earnings calendar is filled with names that might be reporting this week but there are few reports confirmed and that’s not surprising. Not only is it the holiday week but we’re also deep into the mid-cycle earnings doldrums. The names that are slated to report are mostly small and mid-caps with a few large caps scattered in for good measure including three S&P 500 stocks. The outlook for the Q4 earnings reporting season remains unchanged. The consensus estimate for earnings growth ticked higher in the last week but is essentially flat and moving within a range as the analysts upgrade one name and downgrade another. The consensus estimate for growth this quarter is 21.2%, about half the previous quarter’s growth, but we are expecting outperformance. Based on the past few quarters, the index could outperform EPS growth expectations by 1500 to 3000 basis points but we are leaning to the low end of that range. As important as the results will be, the outlook for the next quarter and next year will be more important. The consensus estimates for the Q1, Q2, and FY periods of 2022 all edged higher last week as well but are also trending flat and within ranges except for the 2022 FY outlook. That figure ticked upward this week but has been trending lower for the past two months and points to possible earnings growth weakness in the back half of the year. Our Focus List Our focus list is short but distinguished starting with Nike (NYSE: NKE) on Tuesday evening. The company is uniquely positioned to benefit from consumer and eCommerce trends as well as supply chain disruptions, labor shortages, and rising inflation. We are expecting the company to report strongly with the possibility the revenue was hit by supply/shipping disruptions and margins were impacted by freight, labor, and input costs. The real question is whether Vietnamese production is catching up after the shutdowns last fall. If inventory appears to be a problem share price could fall regardless of the results. Calavo Growers (NASDAQ: CVGW), a small-cap specializing in avocados, also reports on Tuesday night and may disappoint investors. Not only has the rebound in foodservice demand been tepid but lingering issues related to Mexico’s avocado harvest and the rising threat of inflation could impede results. Shares of Calavo Growers might be at the bottom but, trading at over 120X this year’s earnings could be headed much lower too. This is the chart of the week. S&P 500 member Cintas (NASDAQ: CTAS) reports on Wednesday morning. The employer-services company is expected to post flat sequential revenue growth for a YOY gain near 8.5% and we see upside potential in the outlook. Labor markets are strong and trends suggest they will remain tight for some time. Job gains have been below our expectations but still trending above pre-COVID levels which means more uniforms, towels, mats, burn cream, and band-aids for Cintas to deliver. Paychex (NASDAQ: PAYX) also reports on Wednesday morning and should have similarly strong results. The difference is that this employer-services company is focused on technology rather than products and is likely to have an easier time with inflation. The analysts are expecting revenue to fall on a sequential basis and we think that is silly. In our view, Paychex should sustain another quarter of sequential and YOY growth if at a slightly slower pace than in the last quarter. Carmax (NYSE: KMX) reports on Wednesday capping off the list of S&P 500 names scheduled to report. The analysts are expecting revenue to fall sequentially as it has done in previous Q3’s but YOY growth should be strong. The risk is that rising prices and tight supply may impact the volume of sales more than expected. In that scenario, the company’s fixed costs could deleverage and earnings fall short of the Marketbeat.com consensus estimate. 
Until then, remember the trend.
Thomas Hughes
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