PG reported 4Q22 earnings after the close yesterday. They were disappointing. The stock is down by about 5% as I’m writing this. The company has filed its earnings release with the SEC but has scheduled the associated conference call for 4pm today.

To be clear, I know very little about today’s PG. And my guess is that this isn’t the time for defensive stocks. Several things struck me about the release, though.

–a conference call on Friday after the market close. Maybe this is normal for PG, but my experience is that this mostly happens when a company is revealing bad news and/or wants to duck hard questions

–PG lists current headwinds in this order: currency, commodity costs, transportation. The Wall Street convention is to put the most important item first, with the others in descending order of importance. It looks to me as if this is the case here. If I’m reading the release correctly (I’m only putting this caveat in because the number is so high), foreign currency weakness is set to clip over 20% off what PG had thought it would earn in the 2023 fiscal year. Ouch! On the other hand, this shouldn’t come as an overwhelming surprise, since one of the key characteristics of the Staples group in general is very large non-US exposure. A second group trait is the defensive character (meaning relative stability in good times and bad) of its products. As the world crawls out of its pandemic funk, defensiveness won’t be a virtue and exposure to weak foreign currencies will be seen as an increasing negative

–two trends PG has observed that negatively affect current sales are that customers are beginning to run down the stockpiles they amassed during the pandemic, and that, to a minor degree, consumers are beginning to trade down to less expensive offerings in a given product line. The second is a sign of recession; the first I’d call common sense. Yes, both reduce GDP, but the PG story is, so far, much more benign than an overall business cycle downturn

–the fact that currency shifts are a major component of current earnings (bad for a US company, great for a European one) seems to have escaped the notice of the few financial press analyses I’ve glanced through that look at PG vs. peers.

what it is

Paul Krugman had a good recent article in the New York Times on this topic, basically saying that what we’re going through now in the US isn’t a recession, even though the economy is slowing down from its torrid (my word) GDP growth rate of last year.

The common understanding of media commentators is that two consecutive quarters of negative GDP growth define what a recession is. The main virtues of this definition are that it’s simple, the numbers are readily available shortly after a quarter ends and it works more often than not. Plus, you don’t have to know much about economics and the conversation can’t stray into stuff like what the commentator’s training or experience might be.

are we in one?

My guess is that the present case is one of those “than nots.”

The US dipped into the minus column in 1Q22 and appears to have done so again in 2Q22, although a bit less deeply. For the media, then, we’re experiencing a recession. That’s even though we’re not seeing businesses in general beginning to shut their doors and lay workers off.

I see the current situation as unusually complex, even disregarding the external shocks coming from the invasion of Ukraine and the resulting upward pressure on energy and grain prices. Here’s why:

Real GDP growth is a function of two variables: growth in the working population and growth in productivity (meaning investment in plant and equipment or in worker education/training). In the US, annual real GDP growth is maybe 2%, comprised of 1.5% growth in the workforce (half from the domestic population, half from immigration) plus, say, 0.5% from productivity.

During the Trump administration, growth averaged about 1.5% annually, despite stimulus from the 2018 income tax cuts and continuous White House pressure on the Fed to maintain an accommodative monetary policy. The ban on immigration seems to me to be the chief culprit in this sub-par performance, although tariff wars didn’t help matters nor did the administration’s overt white racism. And, as it turned out, real GDP at the end of Trump’s term was actually slightly lower than at its beginning, due to his epic mishandling of the covid epidemic.

My editorializing aside, the main point is that without a system overhaul, 1.5% is probably the best the country can do without creating inflation. In 2021, however, US GDP grew by 3.5%, or well over twice as fast as the present economy can handle without inflation. It shouldn’t be a huge surprise, then, that nominal GDP grew by 10%+ in 1Q22, meaning ballooning, 8%-ish, inflation–some of which was admittedly not home-grown (meaning a result of high-octane domestic fiscal stimulation), but the result of the invasion of Ukraine.

The issue with inflation is that it tends to accelerate if left unchecked, and tends over a period of years to transmute into something like the unholy economic mess that inflation-stoking government policy creates in the US in the late 1970s.

A simple-minded way of looking at things, my go-to approach, is that the most straightforward way of getting the country out of rising inflation mode is to have a 16 month period in which in which the US has no real GDP growth. So basically another year like the first half of 2022. I think this is the Fed’s aim.

In my experience Washington has never been able to engineer a non-bumpy return to normal. So a full year where GDP declines by, say, 1%, shouldn’t come as a shock.

Two issues:

–what has Wall Street factored into today’s prices? …a lot is my guess

–how does oil play into this?

more tomorrow

Before the opening bell this morning, WMT issued a press release saying that the July quarter of its fiscal year (ending January of the following calendar year (like most retailers do)) will be weaker than it initially thought.

Higher prices for gasoline and food have left WMT customers with less money to spend on other items. The company is apparently doing fine in whittling down its excess inventories of durable goods like TVs and kitchen appliances. And the company’s grocery business is doing unusually well. It’s apparel that’s the problem.

Two things to keep in mind in generalizing from WMT:

–although WMT is the country’s largest retailer, it has limited presence in California and the Northeast. In the case of New England and New York/New Jersey, the Arkansas-based company came to this densely populated area relatively late. So WMT has had problems finding good locations for its stores. In California, local merchants lobbied very effectively to keep Walmart out. The company’s roots are in supercenters on the outskirts of towns with populations of under 250,000. It has had less success in penetrating the largest urban areas.

–in terms of income WMT’s customer base (average annual earnings: $48,000) is situated between Target ($80,000) on the higher end and the dollar stores ($40,000) on the lower, and overlaps with both. Its typical customer tends to be older than for either of the others.

So even though WMT is much larger than any of its rivals, it’s not a perfect mirror of all American consumer spending.

It’s not 100% clear, either, what the falloff in spending on apparel at WMT means.

Let’s say the company offers three kinds of blue jeans:

–no-name, not well-made, won’t last a long time jeans for $10

–average, ok-made, won’t fall apart tomorrow jeans for $20, and

–high-end, national brand, maybe with fancy pockets or rivets jeans for $30.

In bad times, WMT sells mostly $10 jeans; when customers are feeling flush, it’s mostly $30 jeans. Since production and distribution costs aren’t all that different, the $30 jeans are much more profitable. They’re also the riskiest, if fashions change or if the economy weakens.

My guess is that the combination of back-to-work, higher interest rates and spiking energy prices has moved us from a $30 jean world to a $10-$20 world much faster than WMT buyers foresaw and that the company didn’t discount the former deeply/quickly enough once it realized what was happening. And it doesn’t have enough of the $10 – $20 jeans customers want.

If so, the preannouncement has roots partly in macroeconomics, partly in a company-specific merchandising mistake. We’ll learn more when Costco and Target report.

A short while ago I got an email containing an analysis of the current sector positioning of US mutual funds and ETFs. I can’t find it at the moment–who knows why–so I can’t attach a link to the underlying analysis. The conclusion, though, was that at the end of June the typical equity ETF/mutual fund was in the most defensive position it has been since the middle of the financial crisis in 2008. This means: underweight tech; overweight defensives (meaning steadier earnings during bad times) like healthcare, utilities, consumer staples; and a larger than normal cash position of 6%+ of assets.

I think this is important, for two reasons:

–2008-09 was the worst period for the world economy over the past century, other than during the Great Depression of the 1930s. Way worse than the internet bubble of 2000. 2008-09 supplanted the economic collapse of 1973-74 as the most horrible period in the working careers of anyone then active on Wall Street. Certainly worse than anything that is happening in the world right now. Put a different way, fund managers seem to already be betting that the current situation will go south from here–and to have already cleared the decks of what they regard as their most economically-sensitive names. Arguably, then, selling pressure from funds will only/mostly result from investors redeeming their shares. Even then, my guess is that selling will try to preserve the current portfolio structure rather than act as a tool to make the portfolio more defensive (or aggressive). If so, redemptions will likely hurt the (overweight) defensive sectors more than the (underweight) aggressive ones.

–early in my career I encountered Robert Farrell, the technical analyst from Merrill who was the most important brokerage house strategist of the late 1970s – early 1980s. His most important tool was his access to the leading portfolio managers of the day, who found him very helpful as a sounding board for discussing and refining their investment strategies. From these conversations, Farrell was able to form a consensus view. He would confirm through trading data that this view had been implemented in portfolios …and he would then recommend to his clients that they do the opposite. His advice/strategy was uncannily accurate for a long time. Eventually, big-time portfolio managers figured out what Farrell was doing, and (my conclusion, because that’s what I would have done) began to lie to him about their actions and plans. He then lost his golden touch and faded into obscurity.

My conclusion: becoming more defensive today makes sense as a betting strategy only on the belief that economic circumstances are going to be worse than the consensus expects–a consensus that’s already making a very big bet that bad stuff will continue to happen. My hunch is I’ll be better off rooting through bombed-out tech names using value-stock asset-value criteria.

The point of my last paragraph from yesterday, which somehow got cut off (maybe I erased it) is that the US at present is a mature, non exceptional, slow-growing country.

So after we get through the current inflationary period–set in motion chiefly by external shocks–there’s a serious limit to how high interest rates can be before they begin to erode growth back toward (and possibly below) zero. My hunch is that tipping point is around where we are not, maybe a tad higher. If so, once the one-time (arguably, if not certainly) shock to prices passes into history, the Fed will likely be backpedaling from rate rises it puts in place from here. The situation only becomes more problematic if energy and food price gains begin to reverse themselves.