Wal-Mart Stock Crashes

The biggest news item of the day on Tuesday was the crash in Wal-Mart stock after disappointing earnings. The stock’s decline of 10.18% was its worst trading day since January 1988. This decline made the Dow the worst performing of the major indexes. Earnings per share were $1.33 which missed the expectation for $1.37. Revenue was $136.3 billion which beat expectations for $134.9 billion. Same-store sales growth was 2.6% which beat estimates for 2.2% growth. Total sales were up 4.1%. Traffic was up 1.6% and ticket value was up 1%.

The reason the stock fell was because of the weak e-commerce growth which is supposed to be a strong point now that the company has integrated its Jet.com purchase. The sales growth from e-commerce was only 23% as Wal-Mart’s ability to catch up to Amazon appears to be hamstrung. Last quarter the company had 50 % year over year growth in online sales. The company is now lapping quarters after the acquisition of Jet.com which might be hurting growth. The fiscal 2019 estimates expect e-commerce to grow 40%. While that’s great, investors were shell-shocked by a disappointment in the most important quarter of the year. The other guidance was for EPS between $4.75 and $5, same-store sales growth in Wal-Mart U.S. of at least 2%, and 4% same-store sales growth at Sam’s Club locations.

The company is planning to try out a delivery program where employees drop off customer orders on the way home. This is in response to Target buying the delivery service Shipt and Amazon considering creating its own delivery service. Target buying Shipt is analogous to Wal-Mart buying Jet.com. The old brick and mortar stores are trying to play catchup to Amazon. That involves paying top dollar for startup firms which usually aren’t profitable and integrating them into their business which means scaling their services to meet the needs of all their customers. It seems clear that investors will bet on Amazon given its successful track record of growth. If Amazon was to compete with UPS and FedEx, their stocks would crater. However, there’s a small chance the company buys a shipping firm like how it bought Whole Foods. Amazon buys established players, while brick and mortar stores acquire startups.

Small Businesses Are Exuberant

Small businesses are as excited about the future as possible. The overall small business optimism index for January was 106.9 which is 0.6 points off the cycle peak in November. 2017 was the most optimistic year ever; 2018 is starting off on a similar pace. One example of the optimism can be seen in the chart below. The net percentage of firms planning to raise worker compensation is at 24% which is the highest since 1989 when the survey briefly jumped to 27. Furthermore, the reports of higher worker compensation increased 4% to 31%. This was the highest reading of since 2000, making it near the all-time 45-year peak. The weird part about this situation is this index has been high for a while, but wage growth hasn’t gotten close to the peaks of the past few cycles. We’ll see if that’s about to change in the next few weeks with this recent spike in the index.

One of my favorite metrics to time the labor market cycle is the employment participation rate for ages 25-54. The metric for workers of all ages has us about halfway through the cycle which is incorrect. You can’t look at the overall number because it is impacted by demographics. As you can see, the ratio for prime-aged workers is at 79%. The average of the past 3 cycles peaks 1.8% higher than where it’s at now which implies the cycle will peak in about 2 years. That will likely coincide nicely with the yield curve inversion which will occur in the next few quarters, meaning they both point to a recession sometime between 2019 and 2021.

If the ratio increases by 1%, you’re betting that the labor market will increase to the levels only seen in the 1990s cycle. That would be quite something because the recovery started about 3% lower in this cycle than the 1990s one. That bet is just like those betting that the Shiller PE will match the 1990s high since that was the only period with a higher Shiller PE than the market has now.

The wage growth should be strong in 2018 since the employment to population ratio shows there isn’t that much slack in the labor market and businesses are expected to accelerate hiring because of the economic growth caused by the tax cut. There may be just enough slack to avoid a big boost in inflation, putting us in a Goldilocks scenario.

Furthering the inflation narrative, the net percentage of small businesses seeing actual price increases in the past 3 months was 11%. This was probably driven by labor costs which makes it confusing because the overall indexes haven’t seen the compensation growth this report is showing. Furthering the divergence in the two perspectives is the survey which asks small business what their biggest problem is. The quality of labor was the number one answer as it received 22% of the votes. That’s 1% lower than the all-time high. On the other hand, the Atlanta Fed tracker has wage growth at 3% in January which is far below the peak of 5.4% growth in the 1990s.

The final small business chart we’ll review is seen below. There is a record percentage of small businesses who say now is a good time to expand their businesses. While I tend to think the small business optimism is a metric you want to fade, if small businesses and large firms are serious about their plans to invest, there should be a big burst of economic activity in the next 12 months. I think this could be the economic bang that brings more wage growth and inflation. It will eventually lead to a bust because it will occur at the end of the business cycle. This means stocks will be worth owning in the intermediate term as corporate earnings growth pushes them up.