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Target Stock: Why the Market Is Getting the Retailer Really Wrong

The chain’s stock has plummeted which creates a buying opportunity. Here’s why that’s a good idea.

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The chain's stock has plummeted which creates a buying opportunity. Here's why that's a good idea.

Target (TGT) - Get Free Report has an inventory problem. The chain found itself with warehouses filled with the items people wanted during the pandemic -- bulky items like televisions, furniture, and exercise equipment -- and it made the decision to sell some of that excess off at a discount to clear room in its warehouses for the holiday season.

Offering lower prices hurts margins and profits, but it's a driver for customers and it strengthens their loyalty to the brand. That's why CEO Brian Cornell's comments on the quarter not being what the company hoped for during the chain's third-quarter earnings call only tell a piece of its story. 

Q3 profitability came in well below our expectations, driven by several factors. First and foremost, we faced an unexpected gross margin rate headwind from a higher-than-expected mix of promotional sales, as guests moved away from full-price purchases. In addition, like the rest of the industry, we're facing a growing financial headwind from shortage, which is running hundreds of millions of dollars higher than a year ago. Along with other retailers, we've seen a significant increase in theft and organized retail crime across our business.

Investors tend to focus on the negative and a company failing to meet expectations, admitting that theft has gone up, and adjusting its holiday season to include a possible year-over-year decline tends to send shares down. That has happened to Target which has seen its share price fall roughly 36% over the past 12 months,

When you dig into what's actually happening, however, you don't see a struggling company. Instead, you see a retailer that's very well-positioned to do well against its chief rivals Walmart (WMT) - Get Free Report and Amazon (AMZN) - Get Free Report.

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Target Saw More Customers, Higher Sales

While it wasn't all good news in the short term, Target actually reported a lot of good news. Customer traffic was up 1.4% year-over-year and those shoppers spent 1.3% more. 

"Because of the deepening level of trust we've established with our guests over the last several years, our top line continues to benefit from growth in guest traffic and new share gains across all of our core categories," Cornell said. "This is particularly notable as consumers are showing increasing signs of stress and pulling back from discretionary purchases. And it reinforces the value of having a balanced multi-category portfolio, which allows us to satisfy our guests' ever-changing wants and needs.

Basically, Target has loyal customers in ways that Walmart and Amazon mostly don't. Yes, Walmart appeals to priced-based shoppers and Amazon delivers a mix of price and convenience, but Target has a special connection with its customer base.

People go to Target to walk the aisles for fun when they only need a few things. Have you ever heard someone say that walk around Walmart for fun? In many ways, Target has the same joy of discovery-based shopping that Costco benefits from as people like to see what's on sale, new brand or celebrity partnerships, and other merchandise even if they may not buy it.

Target's Sky Is Not Falling

In addition to seeing increased foot traffic in its stores, Target also reported a strong same-store sales number.

"Q3 comparable sales grew 2.7%, on top of 12.7% a year ago and 20.7% in the third quarter of 2020," Cornell said.

The pandemic set a very high bar for growth and Target exceeded that bar. Customer needs are clearly changing and that's not a negative.

"In addition to traffic growth, we saw a 1.3% increase in average ticket as guests continue to rely on Target for convenient, reliable one-stop shop. Across our merchandise categories and similar to the second quarter, we saw very strong growth in our frequency businesses, led by double-digit growth in both beauty, and food and beverage," the CEO said.

Yes, people spent less on discretionary items, but they still relied on Target for what they needed. If times get tighter -- and Cornell expects they may -- profits may be lower, but the chain will hold onto its customer base, and likely build an even stronger connection.

Amazon and Walmart may do that to a certain extent, but Target scored a 78 on the most-recent American Customer Satisfaction Index for retail, gaining two points, and finishing near the top. Walmart came in at the bottom with a 71. In the e-commerce category -- an area where Target has not invested as heavily as its rivals -- Target tied Amazon at 78 while Walmart again came in at the bottom with a 72.

While stocks often go down based on an earnings miss and/or guidance that's revised down, good CEOs don't manage for the quarter. Cornell has built Target's connection with its customer and they keep coming back. That will get the company through any sort of economic downturn and while short-term profits may suffer, the chain will come out the other side stronger.    

 

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Warren Buffett’s Advice on Stocks vs. Bonds

In October 2010, Warren Buffett thought that stocks were far more attractive than bonds, a prediction that proved to be accurate.

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“It’s quite clear that stocks are cheaper than bonds. I can’t imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they, the lack of confidence. But that’s what makes for the attractive prices. If they had their confidence back, they wouldn’t be selling at these prices. And believe me, it will come back over time.”

— Warren Buffett, October 5, 2010


From our perspective in mid-2023, Warren Buffett’s advice in late 2010 seems obvious, but it was not self-evident at the time. The United States had recently emerged from a financial crisis and it took years for investors to regain confidence. In retrospect, most of the fluctuations that seemed meaningful to us on a day-to-day basis have receded into mere noise when we zoom out and look at markets over a period of many years. 

With the benefit of hindsight, Mr. Buffett’s observations nearly thirteen years ago were exactly on target. From October 2010 to May 2023, the S&P 500 posted an annualized return of 10.7%. Those who reinvested dividends would have achieved a 12.7% annualized return over that timeframe. Berkshire Hathaway Class A shares have compounded at an annualized rate of 11.8% since October 4, 2010. 

Stocks have done very well indeed, just as Mr. Buffett predicted. How does this compare to the experience of bond investors over the same timeframe?

When I listen to Mr. Buffett comment on bonds, I usually think of treasury securities because Berkshire Hathaway tends to concentrate its fixed maturity investments in treasuries rather than accept credit risk. The occasional drama over the debt ceiling notwithstanding, treasury securities are considered very safe when it comes to credit risk. This lack of credit risk usually comes at the cost of relatively low returns. 

On October 5, 2010, the following yields were available on treasury securities:

Although no one knew it at the time, treasuries were at the beginning of a very long period of extremely low returns. In 2010, the Federal Reserve did not yet have an explicit inflation target, but Chairman Ben Bernanke would soon announce a 2% target. Investing at the short end of the yield curve was a near guarantee of loss of purchasing power of time. A yield in excess of inflation expectations at the time could be obtained in treasuries, but only by purchasing a maturity of ten years or more which involves taking considerable duration risk.

In 2010, fixed income investors might have waited on the sidelines in short term treasury bills expecting that long term treasuries would eventually provide more attractive yields as the economy recovered. While the ten year treasury did offer better yields occasionally, the story of the past thirteen years has been one of consistently low long term yields, as we can see from the chart of the ten year treasury note:

Source: St. Louis Fed

According to the inflation calculator provided by the Bureau of Labor Statistics, the consumer price index compounded at approximately 2.7% from October 2010 to April 2023. Investors in the S&P 500 or Berkshire Hathaway have compounded their wealth far in excess of inflation while an investor in longer term treasury securities would have been lucky to achieve any real return after inflation and taxes.

What if a skittish investor worried about the risk of investing in stocks but found the yields offered on ordinary treasuries unappealing because of the risk of inflation? 

Since 1997, the United States Treasury has offered Treasury Inflation Protected Securities (TIPS) which are meant to provide investors with a real return adjusted for inflation. Just as we have a yield curve for regular treasury securities, we also have a yield curve for TIPS. This is what TIPS yields looked like on October 5, 2010:

Unlike regular treasury securities, TIPS are only offered as longer term securities at auction, although one can purchase TIPS on the secondary market for shorter maturities. For purposes of this discussion, I have displayed TIPS yields for five to thirty year maturities in the chart above. Note that the yields are expressed in real terms. In addition to the real yield, investors receive an adjustment for inflation.

At the time, the yield curve was upward sloping for TIPS, with the five year offering a real yield of negative 0.19% and the thirty year security offering a real yield of 1.54%. 

It is interesting to note the difference between the yield on the regular ten year treasury of 2.5% and the yield on the ten year TIPS of 0.65% which implies that the market expected the inflation rate to be approximately 1.85% over the ten year period. This means that the choice of investing in the regular ten year treasury or the ten year TIPS would depend on the investor’s expectation of inflation. The investor who expected inflation higher than 1.85% would opt for the TIPS over the regular treasury.

Just as the interest rate for regular treasury securities fluctuates over time, TIPS real yields also fluctuate. The following chart shows how the real yield on the ten year TIPS has varied over the past thirteen years:

Source: St. Louis Fed

We should note that the real yield on longer term TIPS can become negative, as we can see from the exhibit above. This happened early in the thirteen year period and, in a more extreme way, during the period following the pandemic. As of mid-2023, real yields on TIPS are back in positive territory again.

The other option for risk averse small investors in October 2010 would have been to buy I Series U.S. Savings Bonds, also known as I Bonds. However, at the time, the I Bond offered a real yield of 0%, lower than the yields available on TIPS.

The bottom line is that unless an investor in October 2010 was willing to take credit risk in bonds and had a high degree of skill, it is almost certain that stocks provided far higher returns. A long-term investor who took Warren Buffett’s advice to heart would have achieved returns well in excess of inflation. In the bond world, an investor would have struggled to keep his head above water in real purchasing power terms.

This raises the question of whether it ever makes sense to invest in bonds over long periods of time, especially during periods of inflation. The answer depends on the yields offered on bonds, the likely level of inflation in the future, and the current valuation of a broad-based index of U.S. stocks. 

I recently wrote an article about the role of TIPS in a fixed income portfolio, but this was in the context of a five year cash flow ladder rather than a long term investment. However, the fact is that the majority of investors will want to allocate a portion of their assets to bonds, especially those who are approaching their retirement years. A bond allocation usually provides a baseline level of perceived stability which permits many investors to view stock price fluctuations with greater equanimity, avoiding panic during the inevitable periods when stocks are declining. 

For U.S. based investors who are unwilling to take credit risk, it makes sense to focus on securities backed by the United States government. Both marketable treasury securities and savings bonds have no credit risk, although all marketable securities, including regular treasuries and TIPS, have duration risk if sold prior to maturity. 

Anyone investing in bonds needs to be aware of the risk of inflation, the topic of an article published yesterday. TIPS and I Bonds are both viable options that can provide limited inflation protection. In my next article, I will provide a detailed comparison of how TIPS and I Bonds work along with my opinion on how they might be used for various investment goals based on the interest rates that currently prevail.


Copyright, Disclosures, and Privacy Information

Nothing in this article constitutes investment advice and all content is subject to the copyright and disclaimer policy of The Rational Walk LLC. The Rational Walk is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.

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Small Bank Insiders Are Buying Shares In Their Companies At A Near Record Pace

Small Bank Insiders Are Buying Shares In Their Companies At A Near Record Pace

On a day when the euphoric AI mania is taking a break (which…

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Small Bank Insiders Are Buying Shares In Their Companies At A Near Record Pace

On a day when the euphoric AI mania is taking a break (which hasn't stopped the Nasdaq from hitting fresh 52 week highs), market flows have reversed modestly out of tech and into small caps, which are surging and reversing just a little of that record QQQ/RTY skew ...

... on the back of aggressive buying of energy (which had been shorted furiously for the past few months) and especially small banks, with the KRE exploding higher, and rising for a 3rd straight week.

And while we wait until today's 4:15pm release of the latest bank deposit and loan data to see if such buying is indeed justified at a time of a persistent bank jog, there is a group of investors that isn't waiting: bank insiders are buying shares in their own companies at the fastest pace since the covid crash, a strong vote of confidence in the industry after the collapse of four regional lenders earlier this year.

While one can debate if management knows something that others don't, and as a reminder the management of SVB and FRC were completely clueless about what was coming and lost everything in just days, the number of buyers has already jumped to 778 in the second quarter through May 26 from 524 in the first three months of the year, according to Bloomberg which cites data from research firm VerityData, and which said the surge is being driven by small and midsize banks. More purchasers stepped up even as share prices sank to multiyear lows in early May.

Another measure of insider sentiment is the buyers-to-sellers ratio, which compares unique insider buying to unique insider selling. The average quarterly ratio for banks since 2011 has been 1.8 to 1, according to the report. So far in the second quarter, the ratio is at a record high of 14.7 to 1.

“Insiders in this group are expressing a strong belief that the regional-banking system as a whole is sound, that there’s not a danger of a wide-scale collapse,” Ben Silverman, director of research at VerityData, said in a Bloomberg interview.

“This is the type of insider signaling you want to see in a sector when it goes down,” Silverman said. “As an investor, if you feel that these are good banks that will be here for the long run, then it’s a buying opportunity.”

“This signifies long-term confidence in these banks’ ability to weather whatever near-term storm there might be.”

In theory, yes it does, but is that merely to convince others to also buy (herd psychology works damn well in such cases), or is it because management actually believes that their stock prices are undervalued. Or, perhaps, management knows nothing and is simply hoping that the Fed will not let any more banks fail.

Whatever the answer, insiders aggressively bought shares of their own companies following the collapse of regional banks including SVB Financial Group’s Silicon Valley Bank in March, pausing only when rules barring insider trading near the release of quarterly results kicked in at the end of the quarter. Buying steadily increased again when the trading window reopened, with May levels exceeding March, according to the data.   

The second quarter has so far been the most active period for insider buying in the industry since the first three months of 2020, when stock prices plummeted at the onset of the Covid-19 pandemic, according to the report.

Tyler Durden Fri, 06/02/2023 - 15:40

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Jobs data shows the truth about the labor market

Follow the trend to understand Friday’s jobs data, which showed 339,000 jobs were created in May while the unemployment rate increased.

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We’ve had some odd job reports over the years, but the key is to always follow the trend. That’s especially important with Friday’s data, which showed 339,000 jobs were created in May even while the unemployment rate increased.

As someone who wrote that we should get job openings toward 10 million in this expansion, I am always mindful of my other labor talking point. If COVID-19 didn’t happen, the total employment numbers in the U.S. today should be between 158 million and 159 million, or in a weaker labor market growth scenario, between 157 million and 158 million.

Today, we stand at 156,105,000, so I think we are still in make-up mode until we reach a range acceptable to a fast economic recovery.

That’s why the jobs data has beaten expectations 14 months in a row. What the U.S. has that other countries don’t is a massive young workforce. While population growth is slowing here, we have the demographic muscle that other countries don’t have — if we didn’t have that, our economic discussion would be different.

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Now let’s look at the labor market on all fronts from the data we got this week to get a comprehensive view of the labor market today. On Friday the BLS reported job growth came in at 339,000, with positive revisions, while the unemployment rate went higher, as there was a drop in self-employed workers.

From BLS: Total nonfarm payroll employment increased by 339,000 in May, and the unemployment rate rose by 0.3 percentage point to 3.7 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in professional and business services, government, health care, construction, transportation and warehousing, and social assistance.

Hours worked have fallen in the last few months, and wage growth is slowing. The fear of 1970s-style inflation was that wages could grow out of control in a tight labor market. In theory, 2022 and 2023 are tight labor markets and wage growth is slowing down. This trend should continue for the next 12 months as well.

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Here is a breakdown of that data for those aged 25 and older:

  • Less than a high school diploma: 5.7% (2 months ago, 4.8%)
  • High school graduate and no college: 3.9%
  • Some college or associate degree: 3.2%
  • Bachelor’s degree or higher: 2.1%.

The noticeable data line here is that the unemployment rate for those without a high school education is up almost 1% from two months ago.

image-3

Here is the breakdown of the jobs created this month, another big month for the government, which typically doesn’t continue at this pace. Construction labor has held up very well, even though housing permits have been falling for some time. The backlog from COVID-19 has been a jobs program for the U.S. as we are still slowly growing the housing completion data.

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So the BLS jobs report is still pushing along, while wage growth is slowing down. Jobs Friday is one piece of the labor pie — we have two other data lines that we always need to keep an eye on to know the health of the labor market: job openings and jobless claims.

As the only person on Earth who talked about job openings data getting to 10 million in this recovery, I am surprised that job openings data is still around that mark. But that is off the recent highs of 12 million.

image-5

At this point of the economic expansion, I am putting more weight on jobless claims data than job openings (JOLTS). For me, the Fed doesn’t pivot, or the 10-year yield doesn’t break under 3.21%, until jobless claims break over 323,000 on the four-week moving average, and that isn’t happening either.

As we can see below, the Gandalf line in the sand has held up the entire year, even though it was tested many times.

image-6

As we can see below, the jobless claims four-week moving average is still far from breaking over 323,000. I chose that number using many different variables as I think when we crack about that level, it will be noticeable to everyone — even the Fed — that the labor market has broken.

From the St. Louis Fed: Initial claims for unemployment insurance benefits increased by 2,000 in the week ended May 27, to 232,000. The four-week moving average declined, to 229,500.

image-8

It’s important to understand the labor dynamics of this economic expansion. We had such a shock in the economy with COVID-19 and a strong labor market recovery that the make-up labor demand, which doesn’t get talked about much, is a significant reason we still see healthy numbers.

Also, it’s essential to understand the demographic difference now and what we had to deal with after 2008. The Baby Boomers are leaving the labor market, and every month that happens, they need to be replaced if demand is growing. This is why having a healthy number of younger workers not only helps with that but also provides replacement consumers, as those who leave the labor market tend to consume a bit differently than younger workers.

At this stage of the economic cycle jobless claims is the data line that matters most. Once jobless claims break above 323,000, then and only then I believe we can talk about a Fed pivot — first in their language and then possibly with rate cuts.

The Federal Reserve is scared to death of the 1970s inflation, and they genuinely believe that breaking the labor market is the best way to prevent that type of inflation from happening. As a country, we are fighting against a group of people stuck in the wrong decade with their economic mindset on inflation.

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