A Leading Indicator for US Economy

27 feb 2023

CME: E-Mini S&P Retail Select Industry Futures (CME:SXR1!)
Last Friday, the U.S. Bureau of Economic Analysis (BEA) released the latest Personal Income and Outlays Report. Personal income gained $131.1 billion (0.6%). Disposable personal income (DPI) added $387.4 billion (2.0%) and personal consumption expenditures (PCE) grew $312.5 billion (1.8%) for the month of January.

Data shows that U.S consumer is resilient. Wage gains and inflation pushed spending growth to a two-year high. In the past decade, PCE gained 60% to $18 trillion. More recently, it surged 50% in the three years since the start of the COVID pandemic.


The hotter-than-expected data indicated that US economy was nowhere near a recession. Additional data from the Bureau of Labor Statistics showed robust job growth in January and the lowest unemployment rate in half a century.

Wary of bigger and longer-lasting Fed rate hikes on the way, all major US stock indexes turned negative in the month of February. As of last Friday, Dow Jones Industrial Average was down 3.8% month-to-date, while S&P 500, Nasdaq 100 and Russell 2000 recorded -2.6%, -0.8%, and -2.4%, respectively.


Consumer Spending Outlook
Consumer spending accounts for over two-thirds of U.S. economic activity. While PCE shot up more than expected last month, it is a lagging indicator and only confirms what happened in the past. Could U.S. consumers spend out of the peril of a recession?

Retailer stock prices are forward-looking and reflect collective market consensus of how much free cash flow the retailers could earn, discounted by their cost of capital. There are indications that the shopping spree may be ending soon.

Last week, Walmart said its U.S. consumer spending started the year strong, but that it expects households to back off through the year, producing weak fiscal-year U.S. sales growth of 2% to 2.5%. Home Depot said consumer spending is holding up, but that it expects a flat sales-growth year overall, with declining profits.

This is a troubling signal. Retailers are supposed to benefit the most from growing consumer spending, but their stock prices have been losing steam in February. As of Friday, Home Depot (HD) has a year-to-date return of -6.1%, while Walmart (WMT) is mostly flat (-0.8%). Other retailers with declining stock prices include Dollar General (DG), -13.2%; Walgreens Boots Alliance (WBA), -3.7%, and Casey’s General Stores (CASY), -3.8%.

Walmart reported Q4 and FY2023 (ending January) revenue growth of 7.3% and 6.7%, respectively. Its operating income fell 5.5% and 21.9%, for the same periods. Digging deeper into Walmart’s earnings release, I find that it keeps sales growing by expanding its grocery business, but those sales are less profitable than general merchandise categories, where consumer spending is leveling off or shrinking.


In theory, the growth of the biggest US retailer could be attributed to one of the following:
• General growth of consumer spending (economic expansion);
• Good business strategy and market share growth (economic trend unknown);
• Consumer downgrades spending from department stores (economic downturn);
• Price increases (inflation).

My interpretation:
1. Consumers tend to keep up with the same living standards. When inflation hits, they maintain the same purchasing habit. Higher price drives spending growth.
2. As inflation deepens, consumers get fewer merchandises with the same budget.
3. Consumers downgrade purchases from department stores to discount stores, and switch to generic products from brand-named products.
4. In a downturn, higher-ended stores get hit first, and discount stores get hit last.

While Walmart manages to grow revenue by doubling down on grocery and online businesses, the weakness in general merchandizes uncovers the real trend of consumer spending leveling off. We may disagree on whether a recession will be coming, however, data from Walmart and Home Depot indicates that the U.S. retail sector is in trouble.

S&P Retail Select Industry Index
S&P Retail Select Industry Index may be a better benchmark for the U.S. retail sector, comparing to the lagging government data and company specified performance metrics.
The index comprises of stocks in the S&P Total Market Index that are classified in the GICS retail sub-industry. Total-10 constituents by index weight are:
• Carvana (CVNA)
• Wayfair (W)
• Sally Beauty (SBH)
• Stitch Fix (SFIX)
• Boot Barn (BARN)
• Children’s Place (PLCE)
• Qurate Retail (QRTEA)
• Leslie (LESL)
• EVgo (EV)
• Abercrombie & Fitch (ANF)

One-year chart above shows that CME E-Mini S&P Retail Select Industry (SXR) Futures tracks the trend of S&P 500 but illustrates higher volatility in the first two months of 2023.

Each SXR contract is notional at $10 times the index. At Friday settlement price of 7004, one March contract (SXRH3) is valued at $70,040. Each futures contract (long and short) requires an initial margin of $5,700. When the underlying index moves 1 point, trader’s futures account would gain or lose $10.

At present, I do not foresee a decisive trend of the S&P 500. It could trend up, go down or move sideways depending on how the Fed rate hikes, inflation, unemployment and geopolitical crises play out.

However, this does not prevent me from expressing a bearish view on the US retail sector. Establishing a SXR short futures position would be appropriate in the negative outlook.

Happy Trading.

Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.

CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs tradingview.com/gopro/