Little seems to be able to slow the charge of the bull over the last ten weeks. Even extremely slow export growth of 1% in China, against expectations of 8%, could not keep the S&P500 from gaining 0.7% last week. Earnings continue to come in at the high end of expectations, though those expectations had been lowered dramatically in the last few weeks and revenue growth in the quarter has been weak.
The week ahead could be a different story with full schedule of key economic reports. Retail sales on Tuesday run the risk of disappointing the markets for a fourth consecutive month. While consensus is for a rebound investors may want to take profits or hedge risks going into the report. Retail names with higher betas and valuations like Apple (AAPL) and Amazon (AMZN) may be hit harder given a surprise downside. Buying portfolio insurance on retail names through buying puts is a good way to protect against downside risk but keep some upward potential intact.
Conversely, data on housing and inflation should be more favorable and could help stocks like Procter & Gamble (PG) and Annaly Capital Management (NLY). Both stocks have underperformed the S&P500 over the past month but may outperform as data supports valuation.
Will Tuesday Catch the Market off Guard?
Tuesday offers a few key economic reports that could potentially determine whether the market continues higher or sees a correction.
Retail sales in the United States fell for the third consecutive month in June, the longest consecutive decline since 2008, and caused many to question whether the country is heading for another recession. Household consumption accounts for about 70% of economic activity. Sluggish real wage growth and an unemployment rate stuck above 8% are weighing on consumer sentiment and the economy in general. Back to school spending may help sales in July and August but may only postpone the pain of further deleveraging in household finances. While the likelihood is to an uptick in sales, investors may want to hedge their bets in retailers and stocks with higher betas ahead of the release against a surprise drop.
Shares of Apple could be sensitive to another disappointment in retail sales. The $582 billion electronic retailer missed earnings expectations by $1.00 in the second quarter on weaker iPhone sales. The rare miss sent shares down more than 4% to trade at 14.5 times trailing earnings. The drop in sales was largely attributed to buyers waiting on the release of the iPhone 5 later this year and should prove to be temporary. The federal judge in the Apple-Samsung patent case called the two sides together over the weekend to express her disappointment in the case so far.
Amazon.com also missed expectations for second quarter earnings though revenue was up 29% year-over-year. The company's operating margin contracted sharply as the $105 billion online retailer expands its network of distribution centers. Shares rose almost 8% even as the company forecast a loss of between $50 million and $350 million in the third quarter on heavy investment in infrastructure. While the company may be positioning itself for greater market share and strength in the future, it is hard to justify a valuation of 287 times trailing earnings. The industry average price-earnings for online retailers is 23.5 times trailing earnings, a metric that would require Amazon to post $9.90 in earnings compared to its current earnings of just $0.81 per share for the last four quarters.
Also out on Tuesday is the U.S. business inventories report and eurozone GDP estimates. The eurozone barely managed to escape a technical recession with a 0.1% annual growth rate in the first quarter. Estimates are for a decline of 0.9% in the second quarter. While peripheral bond yields have been declining over the past few weeks, the region has yet to complement fiscal austerity with any growth measures. As a consequence, declining GDP is keeping debt ratios high despite lower spending by government.
Inflation Data and More Good News for Housing
Producer and consumer price data are released this week and should show a moderation in inflationary pressures in the near term. Excluding food and energy, consumer prices were up 0.2% in June and just 2.2% from the previous 12 months. Apparel and medical care have both posted strong gains since the beginning of the year but almost all other categories have shown fairly weak price increases.
Producer prices have been moderating as well with the headline number gaining only 0.1% in June after three consecutive months of declines. Energy prices have led most of the declines with a 0.9% drop in June, the fourth consecutive month of losses. Prices for consumer foods jumped sharply with a 0.5% increase after falling 0.6% in May.
Lower pricing pressures should help companies in mature industries like Procter & Gamble to improve operating margins over the next couple of quarters. The company posted strong fourth quarter earnings even as net sales fell 1% year-over-year. Foreign currency effects contributed to weakness in sales while organic sales were up 3% on price increases. The company announced $10 billion in cost cuts earlier this year which may help the it further control margins. Still, the company derives 61% of total sales from North America and Western Europe and needs to diversify into faster growing markets to improve sales growth.
Housing starts and building permits on Thursday should show the market continuing to recover, albeit slowly. June data showed the tenth consecutive month of gains for homes under construction and was up 15.3% to 482,000 from the year before. Housing starts were up 23.6% and permits were up 19.3% from a year earlier as well. Despite strong gains, the absolute number of starts reported is still well under historic averages and could mean that the sector will benefit from tailwinds for the next few quarters.
Annaly Capital Management was cut to "underperform" recently by FBR Capital Markets due to its exposure to higher prepayments. The research note did acknowledge that any additional quantitative easing would support book value and offset any decline in prepayments. Shares of the mortgage REIT have fallen by 3% since the beginning of the month but pay an attractive 13% dividend yield. While prepayments may increase, the company has been able to manage exposure in the past and still sports a leverage ratio of only 6.4 times which is lower than many peers.