The Walmart vs. Home Depot Paradox

Weekly Commentary

Market Recap

• Stocks continue to struggle with the prospect of higher-for-longer interest rates. The S&P 500 fell 2.7% this week, and is suddenly down 5% from the February high.
• All sectors but energy were in the red, with consumer discretionary and telecom lagging the pack.
• Meantime, the TSX gave back 1.4%, holding up better thanks to a similar gain in the higher-weighted energy sector.

Global Risks

In recent months, the market has begun to underestimate the downside potential of certain geopolitical risks. Last year, Russia’s invasion of Ukraine brought war and conflict to the fore, yet since then the market has largely forgotten it. The situation will likely continue to ebb and flow but it remains a present concern that could, at any time, have a major impact on markets. Meanwhile, tensions between the United States and China are starting to pick up due to the upcoming primary elections, concerns over the ‘balloon’ incident, semi-conductors and issues of data privacy surrounding companies like TikTok. The popular Chinese-owned social media platform has drawn a lot of focus from U.S. lawmakers and there’s constant attention on technology issues between the two countries—including, most recently, China’s banning of ChatGPT. While we aren’t seeing markets price-in these risks in the near-term, the possibility of escalation should be taken seriously and factored into investors’ allocation decisions.

Bottom Line: Geopolitical risks around Russia or China can flare up at any time, without warning.

Earnings Decline

At the end of last year, we saw some evidence of earnings disappointment in individual announcements and forecasted that others would follow suit in subsequent quarters. Rarely is underperformance a one-time issue—we expected to see lower earnings across the board, and were therefore unsurprised to see the S&P 500’s aggregate profits decrease slightly on a year-over-year basis.¹ Yes, we have seen more modest earnings estimates, which leaves some companies looking acceptable from a stock perspective. But overall, the trend has been of declining profits. Some have even called it an earnings recession, which reveals the negativity that’s prevalent across the market right now. We expect to see subpar results for another quarter at least, tied to three key factors. First—inflation has come off, driving price points lower. And though consumers are still spending at a decent rate, they are being a little more selective and have started to reduce quantities as well. Finally, while we’ve seen supply chains improve during the past year, we are not necessarily seeing input costs decline as quickly as that of end products, which creates pressure on profit margins.

Bottom Line: As predicted, a trickle of poor earnings last quarter threatens to become a flood this year.

Walmart vs. Home Depot

Looking at the state of the consumer, we find the environment currently favours diversified retailers, such as Walmart, compared with specialty stores. Consumers will likely spend less as the layoffs announced in previous quarters come into effect and staple goods offer an area of resilience compared to discretionary items. Walmart mentioned this in their earnings, where they highlighted that sales in non-essential goods were struggling, while essential goods did much better. At Home Depot, for example, price points are under pressure as the value of lumber comes off their pandemic highs. What’s happening here is two-fold—the actual sale price for lumber has decreased, and also demand for construction materials is waning due to the housing market slowdown. At some point, the slump could reverse into a benefit because contractors may see renewed interest in home renovations. There’s an old saying that if you aren’t buying a home, you’re renovating one—that upside could come through eventually, but for now, companies like Home Depot are caught in the middle ground. We’re also hearing comments that the U.S. housing market is approaching a bottom and some regions have seen an uptick in loan originations, which raises hopes that we’re nearing the endpoint. But we are not quite there yet. Right now, we expect consumers to make tough choices about where to spend their money knowing it’s going be a difficult rest of the year.

Bottom Line: As inflation recedes, investors should watch for companies that are vulnerable to margin compression and consumer weakness.

Positioning

Our Multi-Asset Solutions Team recently updated the house views based on what we’re seeing in the market. You can access all of our portfolio positioning decisions via the full report: A Winter of Sunny Surprises.

BMO’S “FIVE LENSES” STRATEGY

¹ Matt Phillips and Emily Peck, “1 Big Thing: Earnings Learnings”Axios, February 23, 2023.

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Originally Posted February 27, 2023 – The Walmart vs. Home Depot Paradox

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