XAP: Consumer Spending Will be the First Shoe to Drop
CME: S&P Consumer Staples Select Sector Index Futures ( XXAP1!)
Last week, new government data showed further evidence of declining U.S. inflation rates.
• On November 14th, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) was unchanged in October, down from 0.6% in August and 0.4% in September. The headline CPI is now 3.2%, down from 3.7%, on an annualized basis.
• The Core CPI, which excludes food and energy, rose 0.2%, after rising 0.3% each in the previous two months. It is now 4.0%, down from 4.1%, on a 12-month basis.
• On November 15th, the BLS reported that the U.S. Producer Price Index fell 0.5% in October, after advancing 0.4% in September. This decline is the largest since a 1.2% drop in April 2020. On an annualized basis, the PPI index rose 1.3%.
• On November 16th, the BLS reported that U.S. import prices declined 0.8% in October, after a 0.4% rise in September. On an annualized basis, import prices declined 2.0%.
• Prices for U.S. exports fell 1.1% in October, following a 0.5% rise the previous month. On an annualized basis, export prices declined 4.9%.
Falling inflation rates are welcoming news. But it will be naïve to think that prices on store shelves are dropping. The harsh reality is that prices continue to rise, but at slower paces.
CPI for All Urban Consumers (CPI-U) is 307.7 in October 2023, up from 298.0 in October 2022, and 252.9 in October 2018. The overall price level for all U.S. goods and services increased a modest 3.2% from the prior-year level. However, the cumulative price increase in the last five years reaches 21.7%.
CPI Index for Food is 325.7 in October 2023, up 13.4% year-over-year, and up a whopping 36.0% in 5 years (from 239.5 in October 2018).
Consumer spending has been holding up well so far, supported by a solid jobs market. However, this is starting to change. Earlier this month, the BLS reported October job growth at 150K, down sharply from 297K in September and 324K in October 2022.
U.S. consumers are struggling under record levels of debt:
• Total Household Debt: $17.3 trillion
• Auto Loans: $1.6 trillion
• Credit Card Debt: $1.1 trillion
• The worst part: Interest payments on $1.6 trillion of student loans restarted last month
Their financial conditions are worsened by rising interest rates:
• Credit Card: 25%
• Used Cars: 14%
• New Cars: 10%
If the U.S. economy enters a soft landing, consumer spending will dwindle due to higher unemployment and higher debt load. Even if the Fed is successful in driving inflation down to 2%, current spending level is not substantiable with the already high prices.
The Retail Sector Underperformed the Overall U.S. Market
The stock market is already showing the warning sign: The S&P 500 gained 17.7% year-to-date as of Friday, while the S&P Consumer Staples Select Sector Index declined 7.2%.
The Consumer Staples sector consists of companies that provide goods and services that people use on a daily basis, like food, clothing, or other personal products. The S&P sector index currently consists of 38 companies. Retailers from Walmart, Target, Dollar General, Bath Body Works to McDonald’s all underperformed the S&P index this year.
Last Thursday, Walmart reported Q3 earnings that exceeded Wall Street expectations. However, it struck a cautious tone with its Q4 outlook after seeing consumer spending weaken. Investors got spooked and the company’s shares slid more than 8%.
Trading with Consumer Staples Index Futures
In my opinion, U.S. retailers face strong headwinds this Holiday season. If sales could not hold up, stock prices could collapse. Unlike the Big Tech companies where investor sentiment alone could push prices higher, retailer stocks stick closer to the ground, where same-store sales and profit margins matter.
The strong headwinds faced by the U.S retailers stem from potential decline in consumer spending. My rationale behind a negative view on consumer spending:
• While living costs surge, consumers ration their purchases. This could mean downgrading from premium brands to store brands or holding off big-ticket items.
• Higher monthly payments in mortgage, car loan, credit card bill, etc. reduce the discretionary income available for other spending.
• Higher interest rates cause payments against floating-rate loans to skyrocket. When the credit limit is maxed out, the spending stop.
• The cutdown in spending would speed up once unemployment rises.
If a trader holds the view that consumer spending will decline, he could express it with a short position in CME Group’s E-Mini S&P Consumer Staples Select Sector Index Futures (XAP). XAP has a notional value of $100 x index value. At Friday closing price of 700.10, each December contract (XAPZ3) is worth $70,010. The minimum margins are $2,750 per contract.
The upcoming “Black Friday” (November 24th) and “Cyber Monday” (November 27th) could be the make-or-break moments for retailers. Sector stocks could sharply rise or fall, as soon as sales data is released publicly.
Hypothetically, if the trader is correct and XAP index falls 5% at 665, his short XAP position would have a theoretical return of $3,500 per contract (=35 X $100).
The trader would lose money if the S&P continues to rise higher.
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 trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Last week, new government data showed further evidence of declining U.S. inflation rates.
• On November 14th, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) was unchanged in October, down from 0.6% in August and 0.4% in September. The headline CPI is now 3.2%, down from 3.7%, on an annualized basis.
• The Core CPI, which excludes food and energy, rose 0.2%, after rising 0.3% each in the previous two months. It is now 4.0%, down from 4.1%, on a 12-month basis.
• On November 15th, the BLS reported that the U.S. Producer Price Index fell 0.5% in October, after advancing 0.4% in September. This decline is the largest since a 1.2% drop in April 2020. On an annualized basis, the PPI index rose 1.3%.
• On November 16th, the BLS reported that U.S. import prices declined 0.8% in October, after a 0.4% rise in September. On an annualized basis, import prices declined 2.0%.
• Prices for U.S. exports fell 1.1% in October, following a 0.5% rise the previous month. On an annualized basis, export prices declined 4.9%.
Falling inflation rates are welcoming news. But it will be naïve to think that prices on store shelves are dropping. The harsh reality is that prices continue to rise, but at slower paces.
CPI for All Urban Consumers (CPI-U) is 307.7 in October 2023, up from 298.0 in October 2022, and 252.9 in October 2018. The overall price level for all U.S. goods and services increased a modest 3.2% from the prior-year level. However, the cumulative price increase in the last five years reaches 21.7%.
CPI Index for Food is 325.7 in October 2023, up 13.4% year-over-year, and up a whopping 36.0% in 5 years (from 239.5 in October 2018).
Consumer spending has been holding up well so far, supported by a solid jobs market. However, this is starting to change. Earlier this month, the BLS reported October job growth at 150K, down sharply from 297K in September and 324K in October 2022.
U.S. consumers are struggling under record levels of debt:
• Total Household Debt: $17.3 trillion
• Auto Loans: $1.6 trillion
• Credit Card Debt: $1.1 trillion
• The worst part: Interest payments on $1.6 trillion of student loans restarted last month
Their financial conditions are worsened by rising interest rates:
• Credit Card: 25%
• Used Cars: 14%
• New Cars: 10%
If the U.S. economy enters a soft landing, consumer spending will dwindle due to higher unemployment and higher debt load. Even if the Fed is successful in driving inflation down to 2%, current spending level is not substantiable with the already high prices.
The Retail Sector Underperformed the Overall U.S. Market
The stock market is already showing the warning sign: The S&P 500 gained 17.7% year-to-date as of Friday, while the S&P Consumer Staples Select Sector Index declined 7.2%.
The Consumer Staples sector consists of companies that provide goods and services that people use on a daily basis, like food, clothing, or other personal products. The S&P sector index currently consists of 38 companies. Retailers from Walmart, Target, Dollar General, Bath Body Works to McDonald’s all underperformed the S&P index this year.
Last Thursday, Walmart reported Q3 earnings that exceeded Wall Street expectations. However, it struck a cautious tone with its Q4 outlook after seeing consumer spending weaken. Investors got spooked and the company’s shares slid more than 8%.
Trading with Consumer Staples Index Futures
In my opinion, U.S. retailers face strong headwinds this Holiday season. If sales could not hold up, stock prices could collapse. Unlike the Big Tech companies where investor sentiment alone could push prices higher, retailer stocks stick closer to the ground, where same-store sales and profit margins matter.
The strong headwinds faced by the U.S retailers stem from potential decline in consumer spending. My rationale behind a negative view on consumer spending:
• While living costs surge, consumers ration their purchases. This could mean downgrading from premium brands to store brands or holding off big-ticket items.
• Higher monthly payments in mortgage, car loan, credit card bill, etc. reduce the discretionary income available for other spending.
• Higher interest rates cause payments against floating-rate loans to skyrocket. When the credit limit is maxed out, the spending stop.
• The cutdown in spending would speed up once unemployment rises.
If a trader holds the view that consumer spending will decline, he could express it with a short position in CME Group’s E-Mini S&P Consumer Staples Select Sector Index Futures (XAP). XAP has a notional value of $100 x index value. At Friday closing price of 700.10, each December contract (XAPZ3) is worth $70,010. The minimum margins are $2,750 per contract.
The upcoming “Black Friday” (November 24th) and “Cyber Monday” (November 27th) could be the make-or-break moments for retailers. Sector stocks could sharply rise or fall, as soon as sales data is released publicly.
Hypothetically, if the trader is correct and XAP index falls 5% at 665, his short XAP position would have a theoretical return of $3,500 per contract (=35 X $100).
The trader would lose money if the S&P continues to rise higher.
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 trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
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