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  • The risk of a recession remains.
  • Data suggests transport, human resources, credit card issuers, and real estate are among the industries that could still struggle.
  • A wait-and-see approach is best for most.

U.S. Gross Domestic Product (GDP) – a measure of economic activity – fell 1.5% year-over-year in the first quarter. Since the 2-year/10-year bond yield curve inverted in March, everybody's debating whether the second-quarter GDP figures will also be negative when released in July, officially putting the U.S. in a recession.

There's reason to believe that happens. In mid-May, the Atlanta Fed's GDPNow forecast for second-quarter GDP was over 2%. Now, it's 0.9% and falling. Its path is similar to in the first quarter. GDPNow was modeling for 1.9% first-quarter growth in March. Its outlook fell to 0.4% in April, but that was still too hopeful, given the actual -1.5% result.

Whether we're already "officially" in a recession or approaching it, recent corporate disclosures suggest profits are thinning.

For example, Walmart  (WMT)  and Target  (TGT)  reported disappointing first-quarter financials because the product mix shifted from higher-margin general merchandise to necessities, including food. This week, Target cut its second-quarter margin guidance only weeks after its less-than-rosy performance because of deteriorating conditions. Now it expects a second-quarter operating margin of 2%, down from 5.3% in Q1.

We've also seen disappointing guidance from Nvidia  (NVDA) , a profit warning from Microsoft  (MSFT)  (citing currency exchange headwinds), Scott-Miracle-Gro  (SMG) , and discount retailer Five Below  (FIVE) . Additionally, semiconductor bellwether Intel  (INTC)  said, "the circumstances at this point are much worse than what we had anticipated coming into the quarter," prompting it to pause hiring.

We've also heard JP Morgan's  (JPM)  CEO, Jamie Dimon (one of the most respected leaders in finance), refer to the current economic situation as a hurricane. Likewise, Tesla's  (TSLA)  CEO, Elon Musk (one of the most mercurial entrepreneurs of our generation), proclaimed increasing worry over the economy, saying he'd like to cut 10% of Tesla's headcount.

It's getting rough out there. If it gets worse, it could also mean tough times for stocks in these other industries.


Cracks were already emerging for transportation stocks at the end of the first quarter. Industry-watcher Freightwaves warned that truckers were rejecting fewer bids at the end of March, suggesting operators were more eagerly accepting offers to keep trucks full. The situation has worsened. In 2021, rejection rates were north of 20%. In March, they'd dropped to 14%. Now, only 9% of bids are rejected.

The Cass Freight Index showed shipments fell 2.6% month-over-month and 0.5% year-over-year in April, leading them to say "The prospect of freight recession is now considerable, as substitution from goods back to services spending picks up pace, and as inflation slows overall spending, particularly via higher fuel prices and by pressing up interest rates."

This week, the May Logistics Managers' Index (LMI) showed flat transportation utilization with the pricing index slowing, falling 8.6 points to 65.3 from April.

Spot prices are falling, and contract rates will likely drop when they need to get updated. The damage is spreading beyond trucking, too. Bloated inventories are bad news for overseas container shipping demand, given Walmart is the largest and Target is the second-largest in container shipments. Target's inventory is 43% higher year-over-year, and when it warned, it said it would be canceling shipments. According to Freightwaves, imports account for 17% of U.S. truckload volumes, and U.S. container imports have dropped over 36% since May 24.

Less shipping demand that results in transportation rates falling is particularly onerous for transports because diesel prices are surging, pressuring margin. On Wednesday, diesel prices hit a record $5.72 per gallon, prompting anecdotal reports of truckers parking rigs. As a result, falling demand and profit could weigh heavily on transportation stocks future earnings results.

In Real Money's Market Recon today, Stephen Guilfoyle writes, "the Dow Transports index gave up 3.81% [Wednesday], with every single component of that index trading lower. The pain there was felt across the truckers, the railroads, delivery services, and maritime shipping rather equally. Ryder System  (R)  was the top performer among the Transports on Wednesday, at -1.75%. The Dow Transports became the first major equity index, on Wednesday, to surrender the 21-day exponential moving average (EMA) this week."

Payroll stocks

Unemployment is a lagging indicator because employers who often hire deep into the economic expansion phase hesitate to let people go who they've just trained. In addition, because hiring models are based on budgets developed during economic expansion, companies are slow to adjust.

The process of moving from hiring to firing takes time. Small businesses with "feet on the ground" insight into changing demand are the first to react. Unfortunately, it takes time for larger businesses to respond to shifts in demand because of bureaucracy. At first, hiring slows, then employers try to rightsize headcount by not replacing workers who leave. Finally, declining operating margins force corporate layoffs to appease frustrated investors.

In May, small business shiring slowed, according to Paychex  (PAYX) , as the "national jobs index saw the largest one-month decline in more than two years." 

According to Automatic Data Processing  (ADP) , Employers added 128,000 workers in May, down from 202,000 in April, but all those job gains came from big employers. Small employers saw a decline of 91,000. 

The more comprehensive May jobs data from the Bureau of Labor Statistics shows U.S. employment rose by 390,000 in May, but employment dropped in retail (unsurprising, given Walmart and Target's comments). On May 6, Real Money Pro's Doug Kass also highlighted that "An area of concern in the jobs report was a pickup in part-time employment for "economic reasons," yet another worrisome sign.

For now, employment is still increasing, but at a slowing pace. Signs of weakness at small businesses and more comments indicating headcount freezes by bigger companies could present a revenue growth headwind later in the year for payroll/ human resource companies that rely on per-employee pricing, module cross-selling, or temporary staffing, particularly if we're in a recession.

Credit card companies

Wages are growing slower than inflation, and that's been the case for about one year. Unfortunately, that's forcing families to make tough decisions about their budgets or take on more debt until the debt collector comes knocking.

In April, revolving credit (mostly credit cards) outstanding grew by $17.8 billion, following a 25.6 billion increase in March. Total revolving credit outstanding is at record levels, and that's particularly concerning, given the average interest rate on credit cards averaged 16.3% in 2020. Rates are higher now because of Fed rate hikes (a lot of credit card debt is variable interest). WalletHub pegged the average rate for new applicants at 18.3% in April. The average rate for store-branded cards is a somewhat astonishing 24.5%!

With rates that high, falling behind on payments is particularly disastrous. Guilfoyle summed it up yesterday, writing: 

"There is no doubt that Mr. and Ms. Average American are relying upon credit more than ever in order to maintain household standards of living. While the castle-bound among us will point to the red-hot US consumer, those of us that have lived on both sides of the fence understand that these consumers would not be packing on revolving credit in an inflationary environment that will ultimately put them, their families and their revolving debt-load is a bad spot unless they felt it necessary."

So, suppose delinquency rates increase with a recession (as they usually do). In that case, defaults are likely to head higher, too, forcing card companies to set aside more money in reserves (an expense item on the bank's income statement). That wouldn't be bullish for the industry, particularly credit card issuers targeting low-to-middle income households exposed to store-brand cards.

Real estate

Housing isn't likely to experience the pain it did in the Great Recession because gunshy lenders haven't been issuing no-doc loans like Pez candy this time. Also, the housing supply is 'tight,' so prices are stickier.

That being said, rising interest rates are crimping housing demand and equity loan demand, creating a headwind for contractors and DIY suppliers. 

Guilfoyle writes today that mortgage "applications contracted 6.5% weekly for the week ending June 3 (last Friday). This was a fourth consecutive week of declining mortgage applications across the U.S. Applications have now fallen to a 22-year low, as applications to refinance dropped 7.1% from last week and new purchase applications fell 5.6%." 

Unsurprisingly, July Lumber Futures fell to $573 per 1,000 board feet Wednesday, a nine-month low, according to Bloomberg.

In "Investors Are Losing Interest in Mortgage Lenders as Interest Rates Rise," Real Money Pro's Ed Ponsi points out that declining loan demand "is happening during what is supposed to be a strong time of the year for housing sales. May/June is normally peak season for real estate activity as many families prefer to move after the school year ends." He says, "With inflation still at unacceptable levels, interest rates -- and mortgage rates -- should continue to climb. That's bad news for mortgage lenders. Shares of these companies are already well off their highs, and according to the charts, more pain is likely to follow."

If a recession causes job losses and rates continue climbing, it's hard to imagine home prices won't eventually fall. We may already be seeing that happen. Rick Palacios Jr., Director of Research at John Burns Real Estate Consulting penned this tweet about their builders' survey this week: 

The Smart Play

Stocks often bottom before a recession ends, but profit-risk to stocks in these industries makes me want to treat them like they're from the "show-me" state.

Staying on the sidelines could be smart until there's conviction the Fed is willing to alter the pace of its tightening and become friendly again.

Falling transportation demand hasn't yet creeped into longer-term contract pricing, but declining spot pricing and stubbornly high fuel prices could make earnings suffer the next couple quarters across trucking, rails, logistics, and overseas shippers. 

A slower pace of hiring, and forthcoming corporate budget tightening, may mean profit slides for payroll/HR and staffing companies. 

And we haven't yet seen much in terms of delinquency and default rates rising, suggesting that's still a problem that investors underappreciate for credit card stocks. 

Home building stocks have already retreated, but I'm still a little nervous about the risk of a longer sales cycle and pricing and unit pressure for future homes. Similarly, stocks that benefit from access to cheap do-it-yourself Dollars (paint, decking, building supply) could still feel the pinch.

Overall, there will be plenty of money to be made in these baskets with more clarity, later on, so add them to your watch lists. However, for now, concentrate on late-cycle and recessionary-stage stocks.

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