CWS Market Review – August 16, 2022

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The Great Summer Rally of 2022

Even if this latest bear-market rally proves to be another dud, you have to admire its resiliency. The market has rallied in the face of slowing economic growth, higher interest rates and persistent inflation. None of these seems to matter.

During the day on Tuesday, the S&P 500 poked its head above 4,325. That’s a place the index has not been since early May. The S&P 500 has now gained back more than half of what it lost during this year’s unpleasantness. There’s even a reasonable, albeit small, chance that the index will close the year in the black.

Sounds far-fetched? We’re only 11% away from a new all-time high. Bear in mind that we’ve gained more than 17% in less than two months. Check out the summer rally:

About a month ago, the S&P 500 broke above its 50-day moving average (the blue line). On Tuesday, the index came within a hair, just 0.02%, of breaking its 200-DMA (the green line).

The reason why it has a decent track record is that the moving average captures the market’s momentum, and the stock market tends to be a trend-sensitive data series. When it’s moving in one direction, the safe bet in the near-term is that it will keep moving in that direction.

Sometimes the market seems like it can do nothing right, and sometimes it can do no wrong. There’s a lot of fancy math to bear that out.

The Housing Recession Has Started

Speaking of not being able to do anything right, have you seen the housing market lately? There was an economic report that came out on Monday that didn’t, in my opinion, get the attention it deserved.

What happened is that a key index of homebuilder sentiment finally turned negative. The National Association of Home Builders/Wells Fargo Housing Market Index fell 6 points to 49. That was its eighth-straight monthly decline.

The reason why this is so important is that 50 is the tipping point. Any number above 50 is considered positive, while any number below it is considered negative. Now we’re negative. Except for a brief period around Covid, this index hasn’t been negative in eight years.

It’s hardly a secret what’s happening. Homebuilders are being squeezed by higher interest rates from the Federal Reserve and also by higher housing costs. All of this is falling on buyers. The index is composed of three parts. The most alarming is that buyer traffic dropped 5 points to hit 32.

While it’s a matter of debate as to whether or not the overall market is in a recession (I don’t think we are…yet), it’s quite clear that the housing sector is in a recession. In response, homebuilders are slashing prices.

The math is simple—home prices are too darned high. Thanks to the Fed, home prices soared during the pandemic. But now, again thanks to the Fed, mortgage rates are climbing. Since early 2021, the rate on a 30-year mortgage has doubled. The combined effect is to push millions of Americans out of the housing market.

The problem is made worse by the fact that there are far too many homes on the market. Home sellers have crowded inventories and few people looking to buy. One stat I like to watch is the supply of new homes relative to the number of homes sold. That’s at its highest level since 2010. Bloomberg notes that in June, “824,000 single-family homes were under construction in the US, more than at any time since October 2006.”

The thing about housing is that it impacts so many different areas. In many regards, the U.S. economy is centered around housing. There’s even a well-regarded academic paper by Dr. Edward E. Leamer titled “Housing IS the Business Cycle.” Note the emphasis on “is.” I think he’s exactly right.

(Side note: Leamer also has a paper called “Let’s Take the Con Out of Econometrics.” How can you not like that?)

Whenever a new home is sold, that spurs the buyers, often a young couple, to head down to Lowe’s or Home Depot to buy new things to fill out the home. Of course, this usually starts with a home mortgage which gives business to the financial sector. The sale of a new home is really the core act that has several spokes that radiate outward.

We can also see the impact on our Buy List. In recent weeks, stocks like Sherwin-Williams (SHW) and Trex (TREX) have felt the impact of a slowing housing market. On Tuesday, Home Depot (HD) reported Q2 earnings of $5.05 per share which was an 11-cent beat, but the company said it expects same-store sales growth of 3% this year. That should be slowing during the second half of the year. Home Depot said that during last quarter, customer transactions fell 3%, but the average purchase rose by 9% to $90.02. In other words, people are paying more for less stuff.

This gets to the key dilemma of the current economy. The broader economy is probably not in a recession at the moment, but its most important sector likely is.

If there is a silver lining to the recent economic news, it’s that earlier today, Walmart (WMT) released a decent earnings report. This is a relief since the company has been struggling lately. After the last earnings report three months ago, traders gave the shares a super-atomic wedgie. I often say that the Walmart earnings report is, in effect, a report on American consumer behavior.

For Q2, Walmart earned $1.77 per share which was a 14-cent beat, but the most important news is that Walmart reiterated its forecast for the second half of this year. The company expects same-store sales to rise by 3% for the back half of 2022. For earnings, that’s still ugly. Walmart said it expects EPS to decline by 9% to 11% for this year.

For Q2, same-store sales rose by 6.5%. That’s not bad. Digging into the numbers, Walmart is being helped by rising food sales, which has been aided by inflation. Here’s an interesting stat via CNBC: About three quarters of Walmart’s market share gains in food came from customers with annual household incomes of $100,000 or more. Rich folks like a good bargain.

Quarterly revenue was $152.86 billion. That works out to more than $1.1 million every minute. It also beat estimates by $2 billion. This report is good news for Walmart and should help to alleviate some concerns about the health of the American consumer. Still, the problem of inflation needs to addressed without delay.

Stock Focus: Polaris

Polaris (PII) is one of those oddball stocks that deserves more respect than it gets. It’s especially intriguing right now because the valuation appears to be quite favorable.

If you’re not familiar with Polaris, the company started off making snowmobiles. They still do today, but they also make all sorts of off-road vehicles, those crazy “slingshot” cars, plus snowmobiles, power boats, pontoon boats and lots of other stuff. They also do a nice business in selling apparel. (Off the record, it’s basically a toy store for adult men. That’s a very good business to be in.) If you want to see an example of wares Polaris has to offer, here’s Chad “Ochocinco” Johnson going off-roading in a Polaris RZR Pro R.

Polaris is based in Medina, MN and they’ve been in business since 1954. Polaris currently has more than 35 brands and it does business in more than 120 countries. Last year, the company did $8.1 billion in sales. Wall Street expects that to rise to $8.5 billion this year and to $8.73 billion in 2023. Global employee count is over 16,000.

Polaris is a good example of a company with a wide “moat.” Not many firms can do what they do. In fact, Polaris is one of the largest holdings in the VanEck Morningstar Wide Moat ETF (MOAT).

These days, Polaris is a complete company that makes parts and accessories. The company IPO’d in August 1987, right near the market top.

The stock has been a massive home run. Since the IPO, PII is up nearly 100-fold. Including dividends, it’s up more than 160-fold. Despite this massive return, the share price today is lower than where it was eight years ago.

Even though the share price has lagged, business continues to go well for Polaris. In 2019, the company made $6.32 per share. In 2020, that increased to $7.74 per share, and last year it rose to $9.13 per share.

In April, Polaris bombed its Q1 report. The company earned $1.29 per share which was 49 cents below expectations. Sales were flat. Three weeks ago, Polaris rebounded with a solid Q2 report. Polaris earned $2.42 per share for Q2 which beat the Street by 33 cents. Sales were up 8% to $2.063 billion.

For guidance, Polaris now expects sales for this year to rise by 13% to 16%. That’s up from the prior guidance of 12% to 15%. Polaris also sees full-year earnings ranging between $10.10 and $10.30 per share. That’s up 11% to 14% over last year. If those forecasts are accurate, that means Polaris is going for just 12 times earnings. Not that long ago, Polaris used to go for twice that valuation. One more thing: Polaris has increased its dividend every year for the last 27 years.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on August 16th, 2022 at 7:22 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.