As a macro analyst, I always start by analyzing all the incoming macro-economic data with my proprietary models and making a forecast on the direction of the economy. Very often, by spotting fundamental changes in the economy, you can front-run company earnings and guidance as they have to adjust to the changing economic environment.
I sometimes receive comments such as “Today macro data just doesn’t matter anymore.” Ironically, when comments like that start to appear is exactly when the macro data matters the most and should be watched carefully.
The reason comments like that appear is because at the end of business cycles, the macro-economic data starts to deteriorate and stocks often times rise higher.
The most common macro-economic indicators peak roughly two (2) years before the start of a recession and stocks typically do not fall until the start if not the middle of a recession leaving the economy moving one direction and stocks moving the opposite way for up to two years. (See Non Farm Parolls Growth Chart Below)
Many macro-analysts have seen the top of this economic cycle occur in 2015-2016 and have been warning of slowing economic activity while stocks continue their climb here. This is normal. (Note: I have not been short stocks for two years. In fact, I still own a portion of stocks in my current asset allocation). What is interesting is when company guidance and earnings start to catch up to the macro data; this is typically a sign that the end of cycle divergence between stocks and the economy is coming to and end. I call it “When the Micro Confirms The Macro”
Last week, Amazon’s (AMZN) guidance may have done just that.
Amazon reported weak guidance for the third quarter in their earnings call last week as well as revenue growth that was lower than the previous quarter. This weak guidance comes on the back of already decelerating growth in both top-line revenue and their retail products only line item. (Detail Below)
Even if Amazon’s next quarter is in-line with their new guidance, it will notch another consecutive quarter of declining growth rates, something that the economic data has been forecasting for the better part of a year.
At the end of the analysis, there is a trade idea for shareholders of Amazon to consider to protect themselves while capturing a 1.2% monthly yield.
The data contains roughly the 30+ important macro data points that are released each month. The table shows the current growth rate as well as the growth rate last month, six months ago, and one year ago.
The reason for this is to indicate clearly if growth is getting better or getting worse. An example to illustrate why the trend in growth (better or worse) is more important than the actual growth rate can be understood using the current stock in focus, Amazon.
If someone told you company X was growing at 12% per year, most people would think that is impressive. If Amazon reported revenue growth of only 12%, the stock would likely tumble. If Amazon’s previous quarters were in the range of 20% growth and then suddenly dropped to 12%, that would be horrible, although it is still growing at 12%.
It all depends on the direction of the growth. That is why if wage growth is 2%, that could be good or bad. It depends if growth the past year was 1% or 3%, that way you know if wage growth is getting better or getting worse.
I hope that example helps explain why the chart is presented in the fashion of “better or worse”.
Before jumping into Amazon’s data and its correlation to retail sales, the chart below is one of my favorite macro charts. Below is a chart of the “Retail Sales Control Group” adjusted for a 12 month moving average of inflation to get “Real Retail Sales”.
As you can see, the chart has been highly accurate in spotting the peak in the economy the past two cycles (note how it peaks ~2 years before the recession/stock market like mentioned above). The chart has also been accurate in spotting the bottom’s of recessions.
The chart clearly peaked in 2015-2016 and is now crashing to levels seen at the start of the past two recessions. It is due to this macro data that it is not surprising to see retail companies, even Amazon, start to report soft forward guidance.
Below you will be able to see how well the micro analysis on Amazon lines up with what you should already be seeing in the macro data.
Shares of AMZN tumbled after their earnings report last week due to missing expectations for earnings per share and also reporting guidance for the third quarter that was lower than what the street was looking for.
The street was looking for revenue next quarter to be around $40 Billion and instead, AMZN reported a wide range of $39.25B to $41.75B.
Although everyone noted that this guidance was weaker than expected, some justified it by saying that they are guiding to roughly 22% growth year over year. Yes, that is very high revenue growth, but remembering the example above, that would represent a year or 4 straight quarters of decelerating revenue growth for Amazon.
The chart above shows how Amazon’s revenue growth accelerated rapidly starting in early 2015 and has now peaked and been declining for a number of quarters.
We have short memories and most of us can only remember Amazon going up every single day but you do not have to go back that far to see a number times were Amazon did not perform well.
Not surprisingly, Amazon performs strong during times when growth is accelerating and has lackluster performance when growth is decelerating.
The chart below breaks down Amazon revenue growth and price action into panels to illustrate this point more clearly.
Let’s now come full circle to the macro data. Amazon has reported weak guidance which should have been expected by people who follow the trends in the economic data carefully (See Non-farm Payrolls & Retail Sales charts above).
If Amazon’s growth rate continues to decline as they themselves are suggesting, this could mark the start of a period of disappointment for Amazon shareholders.
If revenue growth in Amazon drops from 30% in Q3 of 2016 to lets say, 18% in Q4 of 2017, does 18% suggest a triple digit PE ratio?
If growth is 40%, sure a triple digit PE is actually reasonable. But if that company’s growth drops from 40% to 18%, I think that PE ratio will have to come down and it appears this is going to happen to Amazon over the next several quarters.
The next section covers more details between the correlation in Amazon and Retail Sales.
Retail Sales & Amazon:
Amazon has many businesses today but their core business can still be described as ‘retail products’. I know they have a growing AWS business but the margins in that business are contracting and AWS only makes up 10% of total revenue. Nearly 90% of revenue comes from retail products and retail related services so that should be the focus.
The below chart is the growth in Amazon’s retail products revenue and the growth rate of total online sales as reported by the Census Bureau in their monthly retail sales report.
The correlation is unsurprisingly very tight. Total retail sales have been very weak lately but the online sales component has been robust. However, the past few months has shown sharp declines in the growth rate of online retail sales which makes Amazon’s weak guidance very interesting and timely.
Below I will run through the macro-economic data that implies that the growth in online retail sales is headed lower and due to the very strong correlation above, Amazon revenue growth is headed lower too. A sharp drop off in revenue growth will cause a large multiple contraction in AMZN shares.
The year over year growth in online sales reported each month can be volatile but by adding a long term average (black line in the chart below), the trend in the growth rate can be easily seen.
From 2011-2013, a period of declining online sales growth was evident. This was also a weak period in the economy as evident by the heavy support and continued addition of Quantitative Easing by the Federal Reserve. From 2014 through the beginning of 2017, the trend in growth was straight up. This was also a very strong period for shares of Amazon as their revenue growth followed the same path as online retail sales. The trend line (black line) has just rolled over and now has a negative slope.
The following chart of online retail sales growth shows the slowdown more clearly. The growth rate has been nearly chopped in half from 13% to 7%.
It is not a coincidence that Amazon cut their forward guidance when the data shows that the growth rate in online sales has been cut in half.
We are able to forecast the direction in the growth rate of online retail sales going forward with a fair degree of reliability. By doing so, given he correlations outlined above, will give us a stronger read on the next several quarters of Amazon growth.
The first reason to believe that the growth rate in online retail sales will continue to decelerate is simply due to the comparative period. When measuring data in a year over year fashion, last year’s reading is important because that is the denominator in this year’s fraction.
August 2017 / August 2016 -1 = Year over Year for August 2017
Since we have the data for August 2016, we can see if that number was strong or weak, which will give us an indication as to the probable direction of the year over year reading in the months ahead. If August 2016 was really strong, the chances are that it will be hard to post strong year over year growth on top of that.
The chart below shows the year over year growth in online retail sales (black line) and the comparative period (grey bar)
You should be able to spot the trend that when the grey bars are lower (easier comparison) the year over year growth rate goes up and when the grey bars are higher (harder comparison) the year over year growth rate goes down.
The following picture should make that more clear.
Online sales growth has been declining due to increasingly difficult comparative periods and is set to decline further as the comparisons in the back half of the year are some of the hardest in several years.
I do not feel that retail sales will be strong enough to overcome difficult comparisons which will cause the year over year growth rate in online retail sales to fall sharply over the next 6 months. Given how strong the correlation is to Amazon’s revenue, expect the growth rate in Amazon to slow as well.
My feeling is that Amazon knows this to be the case and has begun to reflect this in their guidance.
The main reason why I feel retail sales will not be able to post large gains is due to wage growth.
This is a topic for another article but when you look at wage growth and subtract rent inflation (A closer proxy for disposable income) the growth rate is near 0%.
The inflation in rent and housing has been squeezing consumers and the past 12 months, consumers have barely been able to break-even and show growth above 0% after housing costs.
Amazon will have a very difficult time posting revenue growth that does not decelerate over the next few quarters and that is bearish for the stock. Shareholders of Amazon should take precaution and begin thinking about how to protect their downside in the name.
Below is a covered call trade for shareholders who do not want to outright exit their position in Amazon.
Trade for Amazon Shareholders:
For those unfamiliar with covered calls, below is an image with the definition of a covered call as well as an example.
I want to write a call on Amazon that provides me with above average income and also allows some room for the stock to run.
The best option I found for this is to write a covered call by selling the September 1055 strike price for $18.
This option gives you 5.4% upside to break-even so if the stock recovers from is earnings drop, you don’t miss out, but it also provides above average income.
This option produces an annualized monthly yield of 1.2% or 1.8% over 46 days. That is 27% annualized!
If the stock is below 1055 by September 15th, we keep our 1.2% monthly yield and hold on to our shares.
If the stock rises above 1055, we will sell our shares of AMZN at a price of 1055 for a 5.4% gain from here as well as keep our 1.8% total yield for a gain of 7.2% on the entire trade.
Based on the trends in retail sales and the interesting timing of a reduction in forward guidance by Amazon, there could be some turbulence and some disappointment in this name. This covered call is a good way for shareholders of Amazon to create an additional source of income in a stock that many not have too much more room to run.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.