High valuations, decelerating economic growth, a lack of easy monetary policy, and deflation are all reasons why the stock market has underperformed in the United States, Europe, and Asia so far in 2015. While the U.S. has been better than most, its market has remained bearish. The S&P 500 (SPY) is down 2.3% YTD and has only had two up days versus six down days; the record is one of the most abysmal in the index’s history.
Much of this relates to risk assessment and not an outrightly bearish view on the U.S. economy. No investment bank economist expects a recession in 2015, and none expect a rise in unemployment or a fall in company earnings. However, concerns that the S&P 500 P/E ratio, which crossed 20 in late 2014 and hovered around there since, will see lackluster growth has caused risk-adjusted weightings. Simply put: investors are lowering, but not removing, exposure to equities because they see a bigger risk of a downturn, even if macro fundamentals are relatively strong.
This was the atmosphere when the U.S. Census Bureau reported a fall in retail sales on a seasonally adjusted basis from November to December. In total, sales fell 0.9% month-over-month, although up 3.2% year-over-year. November sales were also revised downwards 3 basis points.
This was far worse than expectations of about a 0.3% decline, and led to another spike in volatility and a fall in equities. At its lowest, SPY lost 1.6%, although it recovered slightly by the end of the day.
There are many ways to read the retail sales report, none of which urges panic but many of which hint at uncertainty and confusion, which is why institutional investors are lowering exposure and putting more of their portfolios in cash.
- Inflation impacts and oil – This is perhaps the most popular interpretation of the low retail sales figure. Excluding gasoline, retail sales were down only 0.3%, much closer to analyst expectations. This suggests that much of the decline is the result of cheaper prices, not necessarily a demand shock. This would suggest the U.S. is experiencing the good deflation, not the bad kind. This is mildly positive, although definitely negative for those looking for an improvement in the SPY P/S ratio or further earnings growth.
- Aggregate demand – An alternative read is that the fall in prices is causing a deflationary spiral and causing people to put off purchases. This interpretation relies mostly on the November revision, which suggests that consumption actually began to weaken two months ago, and has formed a two-month long trend. The fact that sales grew 3.2% year-over-year despite steady population growth and a much improved job market suggests that the U.S. consumer is still saving and not spending. In turn, this is negative for the SPY P/S ratio and for companies’ ability to grow earnings.
In reality, both of these interpretations probably have some truth to them, without being entirely right or wrong. But both end up in the same place: sales as counted by total dollars spent are weakening, which will pressure companies’ ability to grow EPS. Since much of that growth was priced into SPY’s 20+ P/E ratio, it needed to come down. And that’s exactly what has been happening since New Year’s.