Treasury Yields and the Buyback Plan
The Treasury stepped up its long-term bond buyback plan, doubling 10, 20, and 30-year buybacks. Markets will treat this relief as temporary. The economy faces too many other pressures - the Iran crisis, oil prices, and sticky inflation. Treasury Secretary Bessent is doing his best, though it is worth noting he is using the same playbook Janet Yellen started, one he used to criticize.
Whatever he does will not pull yields down, because yields are about confidence: confidence in US Treasuries, in the economy, and in how much inflation is coming. None of that has been settled.
In pre-market trade the market was soft. The 10-year yield rose five basis points to sit at 470. The 475 level is a key ceiling for the 10-year, which has a much bigger effect on the US stock market. The buyback plan might have bought a few weeks before another test of 475, but the yield popped right back up after 24 hours. That fast rebound shows this is not a winning long-term strategy.
The market still sits closer to all-time highs than not.
Small Caps Are Rational, Not a Bubble
The Russell 2000 is up more than 20% year-to-date, roughly 23-24% depending on the index, more than double the S&P 500's gain of over 10%. This is rational, not exuberance. It corrects the underperformance of small and mid-cap stocks since 2022, and it comes down to Federal Reserve rates.
When the Fed raised rates by 5% in 2022, it hit small companies hardest because they carry more debt. Younger firms borrow more and refinance every year or six months, so a 5% jump could not be absorbed. Profit margins and balance sheets deteriorated, hurting the stocks.
Relief came from rate cuts this year and from these companies not taking on much new debt - their debt levels grew slower than inflation over the past three years. So they now have stronger balance sheets, better interest rates, and growth again, because they can take loans, reinvest, and do capex.
These companies once traded at a 30% premium during low-rate periods. They now trade at a 30% discount. On valuation alone they have another 20% to run, before counting their higher growth rates. They could do this again next year.
Retail Earnings: A Split Consumer
Walmart (WMT) is the bellwether for how the US consumer feels. It beat expectations, and its outlook looked stronger than expected, but same-store sales came in a little weaker than expected. Part of how Walmart plans to hit its outlook is tariff refunds to keep prices low. The stock sold off in pre-market. It has not been an outperformer this year.
The takeaway: the US consumer is more cautious and buying less. Walmart beat, but growth was still slow, and slower growth came from its drug/pharmacy side. Walmart also pointed to a K-shaped economy - big expensive items and the higher-end consumer are doing well, while lower-end grocery prices are hurting shoppers. Until oil prices come down, big numbers are unlikely.
The market shows a clear split. High-end consumers with spare income are happy to shop at Target (TGT) and buy new towels. On the low end, Ross (ROST) and TJ Maxx (TJX) are also doing well; TJ Maxx has reported, Ross has not yet. The Dollar General (DG) and dollar store reports will give a fuller read on how low-end consumers are doing.
Target had missteps for years, flip-flopping in ways that pleased no one. Its comeback likely reflects the upper-income shopper returning.
Stock Picks
Etsy (ETSY): Bank of America (BAC) upgraded it to buy from neutral with a $105 price target. The stock is up strongly year-to-date with more momentum ahead. The main catalyst: Etsy sold its Depop division to eBay (EBAY). That was a good sale - it brought extra cash to reinvest and made the company more streamlined and focused, a better-managed, more profitable business with increased growth ahead.
American Eagle Outfitters (AEO): A big underperformer so far this year, though better year-over-year. Tough headlines about the American Eagle women's brand and its sizing are holding the stock down. But all the revenue growth comes from Aerie, a different brand doing well. Dropping the American Eagle name and renaming to Aerie would likely send the stock up. The company needs better repositioning; Aerie is driving all the growth.
Ralph Lauren (RL): Constantly beating top and bottom lines. The high-end consumer is doing well but stays picky about where to spend, and Ralph Lauren keeps hitting the right marketing and tone. Well-run with a strong balance sheet, no missteps, and growth across the US, Europe, and Asia.
