Walmart is outperforming luxury stocks. Is that sign of a coming Fed rate cut?

The U.S. economy is heading for a slowdown that could prompt the Fed to cut interest rates, instead of raising them as markets expect, according to longtime Wall Street strategist Jim Paulsen, the former chief investment strategist at Leuthold Group. He says an indicator known as the Walmart Recession Signal points to “economic stress”: the discount retailer’s stock is now outperforming a basket of luxury-brand stocks, potentially foreshadowing a recession.

The Walmart Recession Signal (WRS) tracks Walmart’s stock performance relative to the S&P Global Luxury Index, a global index of luxury-goods stocks. Walmart is currently outperforming that index. This reflects “economic stress” and weakening consumer demand, Paulsen wrote in a Substack blog post: Walmart’s stock typically holds up better than luxury stocks when U.S. consumers tighten their budgets and turn to discount retailers. Historically, the indicator has reliably signaled an approaching U.S. recession and that the Fed is preparing to cut interest rates to support economic growth, Business Insider notes.

The WRS spiked ahead of the last four recessions, in 1991, 2001, 2007-2009, and 2020. A spike in the WRS has preceded every Fed easing cycle since 1990, Paulsen noted, citing his analysis of Walmart’s relative stock performance and the federal funds rate.

In September, the Fed began a new monetary tightening cycle, raising its target range by 25 basis points. Fed officials signaled their intention to contain inflation amid a strong labor market and inflationary pressure from rising oil prices.

From May through August this year, Walmart’s stock lagged the luxury-goods stock index, “signaling improved consumer health,” according to Paulsen. Recently, however, that appears to have changed. Since August, Walmart has outperformed the S&P Global Luxury Index by around 21%, Paulsen estimated. This could indicate that consumers have changed their spending habits in recent months. Walmart’s stock is up 8% from its late-August low.

“The relative performance of Walmart's stock is telling a different story. One of renewed economic weakness in the coming months which could force policy officials to return to accommodative actions and once again begin cutting the federal funds rate,” Paulsen wrote. “The WRS is but a single indicator and is not necessarily the definitive voice. Nonetheless, its historical ability to lead real GDP growth, the unemployment rate, and Fed actions has been instructive and probably should not be ignored.”

On Monday, LVMH, one of the largest constituents of the S&P Global Luxury Index, reported a 5% decline in organic revenue at its key fashion and leather goods division in the third quarter. LVMH was the first luxury company to report third-quarter results, and its wobbly performance is likely to deepen doubts about whether the $350 billion industry can return to growth after three years of slowing demand, Reuters writes.

Shares of Walmart have gained just 1.3% year to date. On Monday, research firm Gordon Haskett raised its target price on the stock to $135 from $110 per share, implying around 21% upside from the Friday close. Overall, Wall Street is upbeat on Walmart: according to MarketWatch data, 41 analysts covering the stock have “buy” calls versus six “hold” ratings and one “sell.” The average target price is $128.50 per share, 15% above the last close.