This week will feature many important economic readings, but instead of focusing on those readings, let’s focus on earnings. This might seem counterintuitive to some investors, but government numbers can be skewed in many different ways, which has the potential to throw you off track. While individual company earnings can also be manipulated due to financial engineering or even creative accounting (see Enron), this is a much less likely scenario. That said, there’s one key trick to reading consumer sentiment in the current economic environment that applies more today than throughout any other time throughout history.

All numbers as of February 22, 2016.

Top Line vs. Bottom Line

Historically, investors would often ask, “What’s the bottom line?” Translation: “Is the company profitable?” Savvy investors would go on to ask, “Are they growing profits?”

The premise was that there were a lot of ways to grow the top line—such as a retailer opening more stores—but only well-managed companies could deliver consistent profits and grow them over the years. Today is a much different environment.

In today’s world, the bottom line can be manipulated much more easily than the top line. This began with prolonged, record-low interest rates, which has allowed for massive buybacks. When a company buys back its own shares, it reduces the amount of shares outstanding, which then improves earnings per share, otherwise known as EPS.

Any company is going to have more long-term potential if it puts excess capital back into its business, which leads to innovation and organic growth. The problem is twofold. One, upper management teams see a consumer trapped in a deflationary environment, which means they’re slowing down their spending. Therefore, they don’t want to allocate excess capital to growth. Instead, they want to take care of shareholders until the deflationary cycle passes. In most cases, this is the wrong approach because it shows that upper management isn’t confident enough in its product and/or service despite consumer conditions. Two, many CEOs receive bigger bonuses if earnings and share price improve, which leads to extrinsic motivations.

Now you have a little background about what’s taking place with upper management teams and why buybacks are so popular. However, buyback popularity will wane in the coming years, and politics could play a role – not all candidates believe buybacks are healthy. But that’s not of concern at this moment. What’s important right now is that you look at top line results. Sure, retailers can open more stores to show increased revenue, but in those cases, just look at comps numbers instead, otherwise known as same-store sales.

With that said, let’s see how some big-name companies might perform this week, and what it might indicate for the economy.

Earnings Calendar

The first “big-name” to report is Fitbit Inc. (FIT), which will be on Monday. (For disclosure purposes, I own shares of FIT.) It’s not a large position, but the litigation news facing Fitbit seems to have driven down the price too much. Every time I walk into a retail store that sells Fitbit devices, I ask a salesperson how they’re selling. Every time I receive a similar answer: “Very well.” That’s the reason for the flyer. In regards to a reading on the consumer’s health (not their actual health as Fitbit devices would indicate, but how much money their willing to spend), Fitbit isn’t a large enough company to tell us too much. On the other hand, if the top line is strong, which I anticipate (don’t know about the bottom line), then this is yet further confirmation that consumers are allocating more capital to technology opposed to apparel. 

Tuesday should provide a little more information, as the earnings calendar includes Caesars Entertainment Corporation (CZR), The Home Depot, Inc. (HD), and Toll Brothers Inc. (TOL).

Caesars Entertainment might not seem like it would be the best indicator for consumer health, but it’s ideal. In order for the economy to really hum, consumers must have a lot of disposable income that they put back into the economy. One of the best ways to get an early reading on the health of the consumer is to see how Resort Casino companies are performing. Of course, not all consumers gamble, but not all Resort Casino guests are gamblers; some are visiting for the shows and overall atmosphere. If this segment of the consumer population is slowing, then it tells us that consumers have less disposable income than in the past, or that they don’t want to spend right now. I have been bearish on Resort Casino stocks for a few years, and that sentiment won’t change. This doesn’t mean CZR will report poor results this quarter. Anything can happen in one quarter. That said, watch the top line for a clue on consumer health.

As far as Home Depot goes, it has the potential to stand out in a positive manner due to higher interest rates, which indirectly impact demand for homes. Yes, higher interest rates leads to lower demand for homes, but not at the very beginning of the rate hike cycle because consumers want to lock in low rates and rush to buy homes prior to rates moving higher. When consumers buy homes, they spend money on those homes, which helps Home Depot. Once again, this doesn’t mean Home Depot will deliver a winning quarter. After all, we don’t even know if the rate hike cycle will ever materialize into an actual cycle, and most consumers know that.

Toll Brothers is going to be interesting. Last week, Nordstrom Inc. (JWN) reported poor results. You might be wondering what Nordstrom has to do with Toll Brothers. Answer: Plenty ... at least from an investment perspective. Toll Brothers is a homebuilder with a focus on high-end homes. A big part of the reason Nordstrom missed is because middle- to-high-end consumers rely at least partially, and sometimes wholly, on investment income. Investment performance has soured over the past several months for most people, which took a buzz saw to Nordstrom. If the middle- to high-end consumer slowed their spending due to souring investment income, then they’re certainly not likely to have sped up their spending on homes. This could prove to be wrong because anything can happen in one quarter, but watch these numbers carefully. If the results are poor, it means the middle- to high-end consumer has slowed. Combine that with disappointing results from Wal-Mart Stores Inc. (WMT) last week and you have both spectrums of the consumer covered in a negative manner.

Speaking of Wal-Mart, one of its fierce competitors, Target Corp. (TGT) reports on Wednesday. Target is somewhat of a chic discount store, attracting many shoppers from all income levels that are seeking a better shopping experience than Wal-Mart. Target’s results are going to be important. If they’re good, then it tells us that the consumer is simply shifting its spending habits from Wal-Mart to Target (to an extent), and that Target has managed to attract consumers regardless of macroeconomic headwinds. If the results are poor, then it’s very bad news, because it indicates that a quality operation might not be enough to overcome a deflationary consumer. This would be an ominous warning.

If Target’s results are poor, there will be one more retailer with the potential to prove that the consumer is still willing to spend, which is The TJX Companies, Inc. (TJX). As a discount retailer, TJX Companies is on-trend. Consumers of all income levels want to find value, and that’s what TJX Companies offers, which is in addition to a treasure-hunt experience for each visit because the merchandise is constantly changing. If Target and TJX Companies disappoint, look out below. If they both deliver, you can breathe a little easier … for now.

If you’re seeking resiliency, then you might expect to find it with The Kraft Heinz Company (KHC) and Anheuser-Busch InBev SA/NV (BUD), both of which report on Thursday. Historically, these would be good places to hide, but while good quarters are possible, both companies are going through big changes. When you combine that with a deflationary environment, it’s not likely to lead to the type of safety you’re used to seeing in these types of names. If you’re thinking long-haul, then both companies should be considered, but you might not want to dive in with a bulk order right away.

On Friday is none other than Sotheby's (BID), a great company with a unique concept, but I have been writing bearishly on it for more than a year, simply because the stock market had to reverse course from all the reckless activity, which began with prolonged record-low interest rates. This then led to great wealth accumulation for those who could afford to invest, as in the high-end consumer. This pattern has been reversing course as the high-end consumer has been losing money on investments over the past several months (for the most part). This, in turn, slows down spending at places like Sotheby’s. A good quarter is always possible, but a very impressive quarter doesn’t appear to be in the cards. If Sotheby’s surprises to the upside in a big way, then it indicates that logic does not apply to the current market environment. If Sotheby’s doesn’t deliver, then it’s further confirmation that the high-end consumer is taking a hit.

The Bottom Line

If it turns out that consumers aren’t spending on Resort Casinos (CZR), the high-end consumer isn’t spending (JWN, TOLL, and BID), and the low- to middle-income consumer isn’t spending (WMT), then the results for Target and TJX Companies become extremely important. This will tell us if it’s just a matter of discretionary capital being allocated in another way, or if there’s a major consumer problem on the horizon ... or already here yet not fully evident. If TOLL and/or BID deliver in a positive manner, then it indicates that the high-end consumer is still healthy, which means the bull market could resume. If this transpires, this could be a bull with short legs. Please do your own due diligence to determine opinions and investments. 

Dan Moskowitz is long FIT. He doesn’t have any positions in any of the other stocks mentioned above. 

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