KBRA Financial Intelligence

3 Things in Credit: Small Business Signals, Single-B Spreads, and Apparel Company Guidance

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

I learned this week that the inflation episode we have lived through has actually left us better off. This, according to research done by Justin Wolfers, a professor of economics at Michigan. Turns out that, yes, prices of what we consume are up 20% since the beginning of the pandemic. But wages are up 22%. So, we actually can afford 2% more stuff, according to Mr. Wolfers. Apparently, he explains, we are predisposed to focusing on the bad—the higher costs of things—while downplaying the fact that we actually have more money with which to buy those things. Maybe that explains why sentiment surveys are relatively negative, while retail sales have been positive. More on that in a bit.

This week, our 3 Things are:

1. Small business signals. A good place to look for slowdown.

2. Single-B spreads at 16-year tights. Does that make sense?

3. Apparel company guidance. Have you been paying attention?

Alright, let’s dig a bit deeper.

Small business signals.

We have long talked about the dangers of focusing too much on large caps. Sure, what’s going on at Tesla or in AI is going to dominate not only the popular business media, but also Street strategists. It’s easily relatable.

But we’ve always tried to keep track of trends and sentiment in small business. After all, the sector represents half of employment and just under half of economic output. It also serves as an important engine of growth.

So, when we test for underreported, alternative narratives to the soft-landing story, what’s happening in small business is a good place to look. Over the past year, the Russell 2000 has underperformed the S&P 500 by 11 points. No surprise there (what hasn’t?). But the Russell has essentially matched the performance of the S&P 500 equal-weighted index, which means the broadening of buying sentiment we’ve seen in equity markets in 2024 has brought the Russell along for the ride. The index is now up 6.1% on an annualized basis, and trades at 25x forward earnings, above its 22x long-term average.

But it’s not all puppy dogs and rainbows. The Russell is still 16% below its pandemic-era high, set back in Q4 2021. And survey data from the NFIB, the National Federation of Independent Business, has some unsettling undertones.

Small businesses, which derive most of their financing from banks, are finding credit more difficult to get, and rates are higher. As a result, on balance, they have dialed back capex plans, plan to reduce inventories, and plan to hire fewer workers. That’s what the latest survey says. By the way, net plans to hire has fallen steadily since 2021, and now sits at the lowest level since the pandemic. Ominously, this diffusion index has been a foreteller of growth in private payrolls. A significant downdraft there would not be a welcome surprise to credit markets.

It’s no wonder that NFIB members’ outlook for near-term business conditions is at 50-year low levels. In the latest survey, 39% expected “worse” conditions in six months, while only 7% expected “better.” Keep an eye on small business, a useful canary in this coal mine.

Alright, on to our second Thing—16-year tights.

What to make of single-B spreads, which are sub-300 bps, at 16-year tights? Here are a few grounding perspectives:

• One, in periods of low volatility, we do see credit curves flatten—no surprise there. And, for what it’s worth, investors are relatively comfortable with what they think lies ahead: a soft-landing scenario.

• Two, yields matter. Single-B yields have plummeted, from north of 11% in 2022 to today’s 7.6%. But that’s still a touch above the 20-year average.

• Three, technicals matter. On the new-issue-supply side of the equation, a not insignificant portion of what would be single-B bond supply has been siphoned off by private credit. Demand from dedicated high-yield money chasing fewer deals is going to tighten spreads.

• Four, investors have gotten more comfortable with moving into riskier cohorts as markets have grown. The size of the high-yield market, at $1.3 trillion, has doubled in the post-GFC era, giving investors greater confidence of being able to adjust positions more efficiently as conditions warrant.

So, taking all of this into consideration, single-Bs is just another momentum market—bid up as yields remain attractive, and where fundamentals are keeping default expectations historically low. One thing is for sure: At these levels, Treasury volatility is much more meaningful to single-B performance, something single-B investors have rarely had to think about.

Alright, on to our third Thing—Apparel company guidance.

We highlighted, a couple of weeks ago, equity market performance of consumer lenders being under pressure. This week, we thought it would be a good idea to check in on apparel companies as another window into the strength of the consumer.

The news for the most part is not good.

As an indicator, apparel companies are not always the cleanest data points, because performance is driven largely by two things: consumer demand and fashion. Tough to model the latter. But the guidance from managements is instructive, even if it is a function to some extent of trends in fashion.

In the latest quarter, there have been more than a few significant earnings misses. PVH, the holding company for Calvin Klein and Tommy Hilfiger, beat its estimate by 6% but warned on the future. Management referred to the macro environment in Europe as “very tough” and North America as “choppy.” As a result, management is taking a “cautious approach to planning … due to the softening consumer backdrop.” Full-year 2024 revenue is expected to fall 6% to 7%. Margins are expected to be flat. The stock plummeted 22%.

Nike, coming off a big disappointment in its previous quarter, where the stock sold off 12%, followed that up with a cautious outlook that led to a 7% selloff in its shares in the latest quarter. Management acknowledged that the macro environment globally is “uneven” and “subdued,” resulting in its expectation for revenue contraction in its upcoming fiscal first half of low single digits.

Lululemon reported earnings that were up 20% year-over-year and beat the estimate by 6%, but it too warned on guidance. Management alluded to a “shift” of late in U.S. consumer behavior, something they say has been referenced by others in the industry. Specifically, a “softness” has set in, seen broadly across the company’s customer base, making the environment more challenging. The stock sold off 16%.

Victoria’s Secret earnings rose 5% over the year-ago quarter and beat its estimate by 4%. It characterized the macro environment as challenging, with the consumer under pressure. It is adopting what it calls a conservative approach to its planning—that sounds like less capex and lower inventories—as it expects sales to be down low single digits in 2024. The stock sold off 30%.

The lone bright spot we can point to is Ralph Lauren, which handily beat its estimate by 18% on strong holiday performance. It did warn that its outlook, reiterated for fiscal 2024, incorporates inflationary pressures and other consumer spending-related headwinds, potential supply chain disruption, and foreign currency volatility, among others. Europe figures to be especially challenged. Still, its stock soared 17% on the release.

No one’s business is falling off a cliff, and these are anecdotes, but it’s clear to us that the consumer is growing more cautious, selectively trading down or dialing back consumption. With wage growth slowing, and excess savings depleting, the correction is upon us.

So, there you have it, 3 Things in Credit:

1. Small business signals. We see a slowdown narrative developing.

2. Single-B spreads. Spreads are historically tight, but yields aren’t.

3. Apparel company guidance. On the ground warnings of a slowdown.

As always, thanks for joining. See you next week.