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November CPI data came in softer than expected for the second straight month, providing strong evidence that peak inflation is now behind us, and setting supportive ground for the Fed’s latest decision to dial back on its streak of jumbo rate hikes this year. But the market was not nearly as optimistic this time around when compared to the July-August rally and November rally that ensued on signs of cooling prices.
Key market benchmarks staged a “volatile session” following the release of softer than expected November CPI data, with both the S&P 500 and Nasdaq 100 wiping out gains of as much as 2.7% and 3.8%, respectively, to end modestly up about 1%. The swift pullback is likely a reflection of cautious optimism among investors, especially as signs of growing macroeconomic weakness become increasingly prevalent, with the latest inflation print still far from the Fed’s 2% target. This is further corroborated by rising credit card spending, dwindling household savings, diminishing household net worth, increasing recurring unemployment claims, and the Fed’s recent stance to keep rates “higher for longer” that make it hard to dismiss heightening risks of recession (though it is expected to remain mild if it does materialize in the coming year).
And this makes stiff headwinds for Amazon (NASDAQ:AMZN). It has been a tough year, blighted by a slew of unexpected catch-up games – first, a catch-up to pandemic-era capacity constraints that backfired with post-pandemic underutilization due to overly aggressive expansion efforts; then, a catch-up to lacking inventory availability due to supply chain bottlenecks that hampered holiday sales in 2021 which have now again backfired due to the rapid deterioration in consumer spending power. These challenges in Amazon’s core operating environment explains much of the downward valuation adjustment its shares have experienced the past year. And with mounting uncertainties to the global macroeconomic outlook still – which is currently the key overhang on Amazon’s near-term fundamental and valuation prospects – further volatility likely awaits.
Yet, the company remains a steadfast market leader in its core businesses – namely, e-commerce and cloud – with emerging share gains in new verticals like digital advertising as well, despite macro challenges experienced over the past year. While it is more likely than not for the stock to see further volatility in coming months, anticipated pullbacks in tandem with the broader market amid continued risk-off sentiment could create a compelling opportunity for sustained upside potential in Amazon.
Macroeconomic Overview
November CPI cooled more than expected, with the headline print coming in at 7.1% y/y increase (core 6% y/y), lower than the consensus estimate of 7.3%. Lower energy prices, paired with deceleration in shelter costs – which accounts for a third of the CPI – were core drivers of the cool down in elevated price pressures observed over the past year.
Although welcomed news, the market remains cautious of becoming overly optimistic about the latest consumer inflation figure, as it remains far from the Fed’s 2% target. While the cool down is supportive of a potential deceleration in the pace of coming rate hikes, it is likely that borrowing costs will continue to “stay higher for longer” in restrictive territory for the lag effect of monetary tightening to flow through the economy, and ensure inflation is more aligned with the 2% target. This points to a further slowdown in financial conditions within the near-term, which is already corroborated by the latest streak of relevant data:
- Decreasing household savings and net worth: The U.S. personal savings rate has declined to 2.3% in October, the lowest since 2005. The latest data underscores the increasing burden of rising borrowing costs and surging inflation on consumer budgets and overall purchase power. U.S. household net worth has also fallen for the third consecutive quarter as a result of battered valuations across asset classes this year. While the results highlight how previously resilient consumer spending buoyed by “record savings accumulated during the height of the COVID-19 crisis” is likely starting to face weakness, it is important to not overlook the fact that the total value of Americans’ “cash stash” stood at a whopping $4.7 trillion as of mid-year, and likely remains somewhat elevated still when compared to the pre-pandemic level of about $1 trillion.
- Increasing credit card debt: While an increase in household debt is inevitable following one of the most aggressive rate hike cycles in American history, data shows consumers are starting to reach for their credit cards more in recent months. Credit card balances increased 15% y/y in the third quarter, returning to record levels last seen at the eve of the pandemic. The results continue to underscore how the low-debt, affluent days funded by government stimulus cheques during the pandemic are no more. While cumulative American savings remain at levels higher than those during the pandemic, the anticipated continuation of deteriorating macroeconomic conditions draw concerns on how much longer “borrowers will be able to continue to make payments on their credit cards”, especially with the average American savings rate having come down drastically in the past year.
- Recurring unemployment claims: The U.S. saw the highest level of recurring unemployment benefit claims since early February, showing “tentative signs” of a cooling labour market. Continuing claims increased by 62,000 to 1.7 million in late November, while initial claims increased by 4,000 to 230,000 as of early December. Yet, the labour market remains tight, with the unemployment rate of 3.7% still being one of the lowest in decades, pointing to potential wage inflation still that could derail the Fed’s inflation-taming campaign.
- Consumer weakness: As discussed in some of our recent coverages, previously deteriorating consumer sentiment has now materialized into real consumer weakness, which is observed through the rapid deceleration is discretionary goods spending in the past several months. U.S. online prices tracked by Adobe (ADBE) showed an annual decline of 1.9%, driven primarily by “heavy discounting [of] goods to move merchandise” across online retailers. Specifically, demand for discretionary goods like PCs and consumer electronics have dropped drastically, with discounts on related products averaging as high as 18% in November. Even categories that are non-promotional in nature have seen a deceleration in price increases in the second half of the year. The results are corroborated by rising price sensitivity demonstrated across American consumers – more than three-quarters of shoppers have recently indicated they have been searching the web for the best deals and discounts to “maximize their spending power”.
Despite growing signs of weakness, the economy is still relatively strong when compared to the pre-pandemic days. The resilience is primarily backed by still-elevated savings on absolute dollar terms and a tight labour market, but this figure is likely already in the early stages of a structural decline based on recent data as discussed in the earlier section. Paired with continued monetary policy tightening in the months ahead, with Fed Chair Jerome Powell recently vowing there is still “some ways to go” on the inflation-taming campaign which will inadvertently bring about more macro weakness, demand in the market is likely to cool down further. The lag effect of monetary policy that is now catching up and flowing through different corners of the economy more prevalently will also inevitably drive further weakness to corporate fundamentals in the months ahead in our opinion. And this will likely mark the beginning of a higher pace of unemployment – a resilient corner of the economy so far – which economists currently project to be at the 4.5% to 5% range by the end of 2023.
Implications for Amazon
The company’s shares have become one of the most profitable shorts this year, with related sellers pocketing more than $6 billion by betting against any hopes of a recovery in the near-term. This trend continues to corroborate rising risk sentiment on Amazon’s stock – despite the underlying business’ robust balance sheet and fundamental strength buoyed by its e-commerce and cloud moat, it has not been immune to looming macroeconomic challenges.
The bigger question is whether Amazon’s market leadership can weather the looming macro storm. And considering its quality fundamentals and a favourable secular demand environment for its market-leading e-commerce and cloud-computing businesses, buoyed by longer-term digital transformation tailwinds, Amazon shows prospects for coming out on top once the macro headwinds fade, despite heightened vulnerability to further turbulence in the near-term.
Zeroing-In on E-Commerce
Much of the declines in Amazon’s market value this year have been driven by the broader market’s risk-off sentiment in equity investing. Surging borrowing costs have compressed multiples across the higher-valued tech sector as investors rethink the worth of growth and cash flows that are still far out into the future. In addition to declines in tandem with the broader market, Amazon shares have also underperformed key benchmarks despite quality fundamentals, as investors’ confidence sour on the near-term prospects of its recession-prone e-commerce business, which will inevitably bode unfavourably with the unravelling macroeconomic backdrop.
The Near-Term Bear Case
Amazon is already expecting the slowest holiday quarter sales growth this year at 2% to 8%, which implies a potential continuation of declines in its core e-commerce business given anticipated macro weakness across its core operating markets.
The e-commerce arm’s more resilient third party (“3P”) fulfilment business is already starting to show signs of weakness. Amazon aggregators – or owners of multiple online vendors on the platform – have unanimously shifted towards more cautious sentiment on near- to medium-term demand in recent months due to protracted macroeconomic uncertainties. Based on a recent panel conducted by RBC Capital Markets with Amazon’s biggest 3P aggregators, the majority has alluded to “foggy visibility” and “expects softness in Q1” despite bullishness on the longer-term e-commerce demand environment.
Recognizing macroeconomic uncertainties ahead, Amazon has also been eager with promotions for both Prime and non-Prime members alike in an attempt to reach into the diminishing pool of discretionary spending dollars among consumers worldwide. These include Amazon’s inaugural debut of its “first-ever [two-day] Prime Early Access sales event” that took place in mid-October, which follows its annual blockbuster “Prime Day” shopping event in July. Yet, results from the Prime Early Access sales were mediocre relative to momentum observed in July, underscoring the difficult demand environment in retail leading up to the upcoming gifting season:
The first eight hours of Amazon’s October Prime Early Access sale held similar transaction volumes to the “previous 30-day average”, which was a far cry from the 13% lead observed during July’s Prime Day event. The majority of items purchased during the October sale event were under $20, with the “average household outlay (at) about $75” on the first day. And by the end of the October Prime Early Access shopping frenzy, the average order size was down to under $50, a 23% shortfall from July. The results point to weaker demand for more profitable and higher ticket price items, which is consistent with persistent softness in shipments of pricey consumer electronics like PCs and smartphones this year.
Source: “2 Retail Stocks To Watch After Retail Sales Rose In October – We Are Watching Amazon And Apple”
The earlier-than-usual Black Friday sales this year also saw a deceleration in sales growth, corroborating expectations for an imminent slowdown in consumption alongside profitability risks brought upon by heavy discounting on goods sold. Meanwhile, other region-specific shopping events like the “11.11 Singles’ Day Shopping Festival” and “12.12 Shopping Festival”, as well as the consistent flow of non-Prime-exclusive deals offered by the e-commerce platform in an attempt to shore up demand and “ease inventory build-up” also adds to said profitability risks in the near-term.
The low-dollar average order size observed in Amazon’s recent shopping events also underscores the recession-prone nature of its e-commerce business. First, the diminishing figure is consistent with the need for competitive discounts to drive sales, which will continue to weigh on Amazon’s e-commerce earnings. Second, the diminishing figure harbingers greater vulnerability to a more prominent slowdown for Amazon’s e-commerce platform. Not only does the low-dollar average basket size at checkout imply overall weakness in consumer spending on discretionary big-ticket items like consumer electronics and PCs, but it also suggests the marketplace largely caters to less affluent to average American households. And these have been two of the most recession-sensitive and hardest hit consumer segments amid surging inflation and rising borrowing costs over the past year – Americans in the “bottom one-fifth of the income distribution saw cash [savings] fall 73% in the first half of 2022”, with the figure still deteriorating as financial conditions tighten.
To offset the looming impact of cyclical headwinds on its retail segment’s near-term fundamental prospects, Amazon has embarked on an aggressive cost-cutting stance that included massive layoffs and abrupt cancellation of some speculative projects that might not come into fruition for years. But that is likely insufficient when compared to the massive discounts that currently average in the 30% to 40% range to drive consumer purchases and inventory outflow, underscoring increasingly prominent fundamental weakness for Amazon’s e-commerce arm in the near-term.
The Long-Term Bull Case
Despite the cyclical headwinds facing Amazon’s e-commerce segment, it remains the leading platform for online marketplace sales as businesses embark on a structure transition to digital. From a consumers’ perspective, Amazon remains a well-liked destination for purchases of both necessities and discretionary goods, with the platform’s sprawling 1P and 3P business both offering a wide variety of choices across different qualities and pricing segments. And from a vendor’s perspective, Amazon remains a critical gateway into sprawling e-commerce opportunities:
Based on recent commentary from Amazon aggregators, [Fulfilment by Amazon, or “FBA”] remains the “best platform in terms of margins and operational efficiency despite increasing fees and a more challenging operating environment”, with many seeing the platform as key to brand building. While many of the vendor aggregators have acknowledged that the deteriorating macroeconomic outlook is weighing on the inventory situation, they expect said headwinds to start alleviating by mid-2023. And despite growing competition within the online marketplace sector against newer platforms like Walmart (WMT) and Target’s (TGT) expanding e-commerce reach, Amazon is expected to remain the primary beneficiary of longer-term secular growth trends in e-commerce, given the attractive margin profile enabled by FBA still…3P vendors currently account for more than half of all merchandise sold on the platform, with related sales generating higher margins for the e-retailer.
Source: “2 Retail Stocks To Watch After Retail Sales Rose In October – We Are Watching Amazon And Apple”
Although the Amazon marketplace is still viewed as a purpose-driven shopping destination, with “more than one in four Amazon purchases [taking] three minutes or less”, the platform continues to work towards unlocking its potential of becoming the digital equivalent of shopping malls, capable of encouraging product discovery and driving adjacent purchases. This drives back to Amazon’s roots of disrupting status quo with continued innovations, with “Inspire” being the latest shopping feature added on the e-commerce platform.
Currently only available to a handful of Amazon shoppers for beta testing, the Inspire feature will generate a discovery feed of products offered of the platform in a way similar to TikTok. Shoppers can configure the feed based on their preferences to ensure products displayed are tailored accordingly. If testing continues successfully with positive user feedback, the feature is expected to “go national in the next few months”.
Inspire comes after Amazon’s latest efforts to add “Amazon Live” with influencer marketing on its platform, with aims to better showcase its product catalogue and expand consumer engagement:
Amazon has also added new features in recent years, such as Amazon Live, which invites influencers to livestream their must-have products available on Amazon.com, to boost engagement traffic and drive higher e-commerce sales growth. The trend first emerged on China’s dominant e-commerce platforms and has already shown promising results; livestreaming e-commerce is expected to grow at a CAGR of 39% through to 2025 and account for 25% of the country’s total e-commerce sales. And similar growth could be in store for Amazon as it extends its livestreaming e-commerce availability to members outside of the U.S. marketplace in the long-run.
Source: “Where Will Amazon Stock Be In 5 Years?”
With the platform still well-positioned in capturing longer-term e-commerce tailwinds stemming from both the shift in consumers’ shopping habits and the need for a fulfilment one-stop-shop for vendors, the segment’s longer-term growth prospects remain intact. And from a profitability perspective, currently compressed margins face high probability of becoming restored once macro headwinds subside as more profitable 3P sales gain momentum alongside accelerating e-commerce adoption.
Risks to Our Thesis
As much as we believe that Amazon’s latest declines have more room to run before staging a structural recovery towards greater gains buoyed by its robust fundamental prospects, there are several risks to consider, particularly considering ongoing uncertainties over the global macroeconomic outlook.
Specifically, there is potential that market sentiment is more optimistic than what economists and Fed officials currently predict, given pricing on rates futures contracts remain fixed on a sub-5% terminal rate while the FOMC median estimate is currently at 5.1%. With rising risks of recession, some investors are more optimistic on the potential for a Fed pivot towards rate cuts within the next year to stem a policy mistake. Equity markets also did not respond too adversely to the Fed’s latest reaffirmation on its hawkish stance on keeping rates higher and in restrictive territory for longer, with “big losses [shrinking] to little ones” across the S&P 500 and Nasdaq 100 during Wednesday’s session (December 14) to close down by less than 1%:
The S&P 500 was twice down by as much as 1.3% and twice came close to erasing the decline…Still, for bulls who bid up stocks by almost 7% since the last meeting and were bracing for a sterner bashing, the closing print — down 0.6% — was a victory.
Source: Bloomberg
If the market’s resilience does ride through looming risks of recession despite growing signs of rapid erosion of corporate fundamentals in the near-term, then there is no near-term short opportunity for Amazon, given anticipated weakness discussed in the foregoing analysis could potentially be priced in already.
Final Thoughts
Amazon currently trades at more than 64x estimated earnings, which is not cheap on a relative basis to peers with similar growth and profit margin profiles, although not totally unreasonable given the company’s quality earnings and the premium attributable to its market leadership moat. Meanwhile, the tech-heavy Nasdaq 100 still trades “slightly above its 10-year average” at 21x estimated earnings. Even if Amazon’s anticipated near-term fundamental weakness has already been priced in, the stock is unlikely to dodge a further downtrend in tandem with the broader market as valuations adjust further to elevated risks of a downturn.
Despite expectations for more turbulence for Amazon shares over the coming months, it also provides a profitable opportunity to partake in the stock’s longer-term upside potential supported by the company’s market leadership in key digital growth trends, as well as its solid fundamentals. Although Amazon is a high-quality company, the sheer size of the business’ market share and balance sheet today implies that the days of lucrative expansion are likely limited, which makes any upcoming downtrend posed by looming macroeconomic pressures an attractive entry opportunity to maximize longer-term upside potential in the stock.
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