FINANCIAL REPORT: Amazon and Whole Foods in the News

On Friday, Amazon’s surprise announcement that it is trying to buy Whole Foods for $14 billion in cash made waves throughout the US financial markets. Grocery stores such as Kroger, Safeway and Sprouts all booked large declines, while Whole Foods increased by almost 30 percent over its closing price on Thursday. The move by Amazon to move into grocery retailing is an interesting one.

The cost to run brick and mortar stores is something Amazon has always criticized its competitors for. However, the company has been trying its own hand at retail outlets over the past few years with a grocery store and a book store up and running in the Seattle area. This buyout seems to be more of a real estate play than anything else, as Whole foods has a nationwide presence, yet not so many locations that the chain would be a logistical headache for Amazon.

Wal-Mart appears to be one of the main targets of the deal if analysts are correct; its stock moved down about 4.5 percent on Friday following the announcement. In the Hybrid model section below, I briefly discuss why this seems like an overreaction on the markets’ part regarding Wal-Mart. As of early trading on Monday, Whole Foods is currently trading above the takeover price that Amazon announced.

It would be very ironic if Wal-Mart outbid Amazon for Whole Foods and was able to close the deal.

U.S. News Impacting the Financial Markets
The Federal Reserve here in the US grabbed most of the headlines early last week as it held its June FOMC meeting on Tuesday and Wednesday. The outcome of the meeting was a rate increase of 0.25 percent, taking the target range from 0.75-1 percent up to 1-1.25 percent. This increase was already accounted for in the markets, both on the equity side and the fixed income side of investing, so there was little direct market movement from the release of the statement. The increase comes as the economic data the Fed has said it is looking at to determine the correct time to raise rates has been showing signals that would counter this move.

On the labor market front, the unemployment rate has largely continued to push lower in 2017 and is meaningfully below the Fed’s full employment target. Inflation, on the other hand, continues to be the primary problem for the Fed as it is just not present in most of the US. The Fed has a target inflation rate of 2 percent, but the most recent CPI and PPI data puts the rate closer to 1.7 percent and moving lower.

In fact, the CPI data point for the month of May posted a decline of 0.1 percent, which signals deflation, something the Fed absolutely does not want to see picking up.

Deflation is something all central bankers fear as it is very difficult to break the deflationary cycle once it gets going in earnest. Other than cutting rates and throwing money at the economy, central bankers have little else to combat deflation. Retail sales, while not explicitly part of the Fed formula in determining when to move rates and by how much, could also come into play in the psychology of the Fed as we saw in May the first decline in sales in 16 months. These above-mentioned factors seemed to be taken into account by one FOMC member, Minneapolis Fed President Neel Kashkari, as he dissented against the decision to raise rates and voted to keep them unchanged at the June meeting.

The Fed’s current balance sheet plan was another area of focus for the markets last week as Chair Yellen provided more detail.

The Fed plans on shrinking its balance sheet over the next several years, but the details of the process remained elusive until last week’s FOMC statement addendum and Chair Yellen’s press conference. The plan to lower the Fed’s balance sheet deals with the Fed not reinvesting all the principal payments it receives during a month. There will be caps in place that will allow for reinvestment only after a certain amount of payments have been received and not reinvested.

We now know that the first set of caps will be $6 billion per month for treasuries and $4 billion for agency debt. This $10 billion in aggregate caps is a little higher than many Fed watchers had been expecting, but will need to be substantially increased if the Fed is going to work $2.5 trillion off the current $4.5 trillion balance sheet in any reasonable amount of time.

The only other major news last week in the U.S. surrounded the media’s continued infatuation with President Trump. Last week, it was Attorney General Jeff Session’s turn to be in the hot seat, answering questions before Congress. One could tell, if they watched any of the testimony at all, that Sessions is a very practiced attorney as he said next to nothing and got around answering the most direct questions Congress wanted answered. Thankfully, the markets have largely stopped paying attention to the proceedings in Washington DC as they relate to going after President Trump.

However, the markets are still closely watching the proceedings for tax reform and infrastructure spending. The more time spent on going after the President means less time to get meaningful legislation done before the August recess. At some point, the market could surmise that meaningful legislation is highly unlikely in the current political environment in DC, which would likely push the markets notably lower as a corporate tax rate cut in 2017… and personal tax rate declines have already been accounted for in the current lofty earnings expectations for 2017 and 2018.

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Peter Johnson

Analyst Peter Johnson provides financial and investment information through Callahan Capital Management in Steamboat Springs, Colorado.