Beware the rebound in retail stocks

Retail sector bottoms on mixed results

The Retail Sector (NYSEARCA:XRT) is rebounding but we don’t think investors should cheer too loudly. The move is driven by the combination of oversold markets and mixed results and we don’t see it going very high. While the XRT Retail Sector ETF is bouncing from a technical support target but that target is a weak one and there is strong resistance ahead. Resistance at the $70 level was once a strong support level so should now be viewed with absolute caution. A move above that level is possible but we don’t think it’s coming.

The more likely scenario is that a trading range will form with resistance at the $70 level as the high end. Rotation will drive the market action over the next quarter or so, rotation from the underperforming names into the higher-quality pandemic winners that have proven to have true legs, and there is the possibility of even lower prices for the ETF as well.

The Fed triples-down on inflation

The minutes from the last FOMC meeting were met without much ado but the message they sent is clear. The FOMC has been slowly ramping its stance on inflation and is now forecasting a more aggressive series of hikes than the market was pricing in. To paraphrase, the committee’s stance now is that it is prepared to move past tightening policy to restricting economic activity and forcing a recession. The odds of aggressive rate hiking, however, have come down based on the CME’s FedWatch Tool. The FedWatch Tool tracks Fed Funds Futures and predicts the pace of interest rate hikes, a forecast that has tempered in the last few weeks.

The FedWatch Tool had been predicting as many as 12 25 basis point interest rate hikes by December but is now pricing in only 7. In the near term, the market is expecting 50 basis point hikes for the next 2 meetings but only 1 in September. The odds of 75 basis points of increase, 3 X 25 bps, was as high as 12% for June but that fell to only 3% but there is risk in the outlook. The risk in this outlook is the data and we will be getting a new data point on Friday. The PCE Price Index is expected to hold flat on a month-to-month basis at 0.3% and subside to only 4.9% on a YOY basis, both of which are hot numbers in our book.

The risk here is that price increases could easily outpace the expectations and the impact on the consumer is still there regardless of the pace of FOMC action. The latest Retail Sales data was weak at only 0.9%, below the consensus, and well below the pace of inflation. The take on this is that a volume-based recession is already underway in consumer-land, and the U.S. is only producing growth because of higher pricing.

The technical outlook: The S&P 500 moves lower on deflating estimates

The S&P 500 (NYSEARCA: SPY) has been moving lower and will likely continue to move lower despite the rebound in retail. The Marketbeat.com consensus estimates for all three of the remaining quarters of 2022 are moving lower and we don’t see the bottom yet. Turning to the chart, the S&P 500 appears to be at a bottom but it does not yet look like the absolute bottom for this bear market. While futures action is moving higher, it is still below the near-term down trend line, the short-term EMA, and the key resistance target at 4,100. The index may move up to the level but we would expect to see it produce strong resistance to higher prices unless the PCE price index comes in well below the expectations.