Market Licks Wounds, Pondering Geopolitics, Recession Fears, and a Housing Update

(Tuesday Market Open) So far this week, investors are shying from risk and appear to be leaning toward fixed income after growth sectors took a pounding yesterday. Geopolitics could be back in the picture, too, after missiles hit Russia late yesterday, and today brings a run-off Senate election in Georgia.

The question is whether yesterday’s hitch in the rally that began a month ago is a pause or something more. Some say investors are optimistic going into the end of this very eventful year. But a lot of evidence stacks up against that.

Consider how the market has reacted to recent data. It fell on strong jobs Friday and IMS Services data on Monday, but also dropped last week when manufacturing data disappointed. Whether data is “good” or “bad”—as so many hope for weakness that might pause the Federal Reserve—the market’s had the same negative reaction.

This situation shows the fragility that prevails right now, and if inflation data later this week and next shows price growth continuing to slow, it may mark the point where the market shifts its primary focus from inflation fears to the economic uncertainty that awaits us going into 2023.

All this creates an uncertain environment where rallies may be hard to sustain, especially with the S&P 500® index (SPX) already up 15% from its mid-October low and worries about possible soft Q4 earnings (see below).

Morning Rush

• The 10-year Treasury yield (TNX) fell four basis points to 3.55%.
• The U.S. Dollar Index ($DXY) fell 0.3% and is back below 105.
• Cboe Volatility Index® (VIX) futures were up slightly, near 20.7.
• WTI Crude Oil (/CL) is down sharply from last week’s highs, back below $76 per barrel.

There’s no economic data or earnings of note this morning, but Toll Brothers (NYSE:TOL) reports after the close and could provide some insight into the housing market as mortgage rates fall from recent highs. Their call is scheduled for tomorrow morning. TOLL, a builder of luxury homes, cited a “softer demand” environment and reported lower-than-expected deliveries when it last posted earnings in August.

Jamie Dimon, CEO of JPMorgan Chase (NYSE:JPM) and an influential voice on Wall Street, told CNBC this morning that an eroding wealth effect could cause recession next year. He noted that households are now spending down pandemic stimulus money that helped fuel the economy’s growth in 2021.

Numbers to Know

• 17.6: That was the forward price-earnings (P/E) ratio for the SPX heading into this week, and it may spell trouble because analysts’ earnings estimates are falling. The forward P/E has climbed to 17.6 from 15.2 since September 30, research firm FactSet noted, even as earnings per share (EPS) estimates for calendar year 2022 and 2023 decreased during this time.
• -5.6%: That’s how much analysts’ Q4 earnings estimates have dropped over the last two months, according to FactSet, which is a much more dramatic decline than the 2.7% average for the first two months of a quarter over the last 10 years (40 quarters).
• -3.6%: That’s the decline in analysts’ calendar-year 2023 average S&P 500 EPS estimates over the past two months, FactSet reported.

All this accompanied a 5% rise in the SPX during November. Typically, rising index prices and falling earnings estimates aren’t the type of yin and yang that can just go on indefinitely. At some point, there tends to be a reckoning. Either earnings won’t be as disappointing as analysts believe, or the stock market will need to stop and catch its breath.

Over the years, investors got used to sky-high P/E levels, in part because low interest rates kept stocks attractive even at elevated valuations. That particular tailwind isn’t available these days.

Thinking Cap

Turning back again to last week’s mostly strong November Nonfarm Payrolls Report, some wonder why labor force participation continues to fall even as employers keep raising wages. Wouldn’t higher salaries draw people off the sidelines?

As The Washington Post noted, however, employers’ needs and workers’ skills aren’t evenly matched. A lot of people lost their tech industry jobs recently, but the economy is short on nurses, not programmers. Someone who just got laid off from Twitter (TWTR), Meta (NASDAQ:META), or Alphabet (NASDAQ:GOOGL) isn’t going to take a hospital nursing job, the Post said, quoting a Monster.com economist.

If you’re worried about more “hot” data later this week with Friday’s Producer Price Index (PPI) reading, consider these words from Charles Schwab’s Chief Global Investment Strategist Jeffrey Kleintop. He told Morningstar that he believes “PPI pressures have peaked out based on the decline we’ve seen in supply chain problems” and that he’s expecting that the upcoming PPI print may reinforce the overall message of central banks stepping down the pace of rate hikes.

Reviewing the Market Minutes

It’s been a long time since a day like Monday. To find the last session with such a steep drop for the SPX, you’d have to go back to November 9. Yesterday’s selling kicked off after the ISM Services report for November showed higher-than-expected activity, raising worries about how aggressive the Fed might ultimately get. Mega-caps took a blow, with Tesla (TSLA) suffering the most even though the company denied news reports that it would reduce production at a factory in China.

The dollar and Treasury yields jumped on the ISM Services news, weighing heavily on stocks yesterday, but both yields and the greenback remain near recent lows. “Growth” sectors like energy, consumer discretionary, info tech, and financials all had a rough start to the week.

Here’s how the major indexes performed Monday:

• The Dow Jones Industrial Average® ($DJI) shed 482 points, or 1.4%, to 33,947.
• The Nasdaq Composite® ($COMP) fell 1.93% to 11,239.
• The Russell 2000® (RUT) dropped 3.04% to 1,835.
• The SPX fell 72 points, or 1.79%, to 3,998.

Talking Technicals: RUT took the hardest hit of any major index yesterday, falling 3%. This came after it spent last week treading water even while the SPX and $COMP reached new highs for their recent rallies. RUT hasn’t posted a new high multi-month high since November 15 when it briefly topped 1,900. A couple of attempts at that same level fell just short last week, which might’ve made it more technically vulnerable to begin with. Interestingly, last month’s 1,905 high corresponded closely with a 1,906 high back in September, so that area looks like one that could continue posing resistance for the RUT.

Three Things to Watch

Retail Investors Speak Out: Even as the stock market rose in November, investors tracked by the TD Ameritrade Investor Movement Index® (IMX) cut back their stock exposure that month. Clients were net sellers of equities overall, only adding money in the consumer discretionary, utilities, and energy sector.

The headline IMX fell to 4.17 in November from 4.25 in October, a low reading historically. Here’s what my colleague Shawn Cruz, head trading strategist at TD Ameritrade, had to say about the IMX reading:

“It’s not unusual to see retail investors reducing exposure to the markets toward the end of the year, which is sometimes influenced by risk moderation tax plays, a desire to take profits, or other factors. But overall, it’s clear that clients continued to keep exposure low and take a mindful, risk-off approach in November. If predictions are correct and inflation concerns ease as market volatility moderates, we may see sentiment shift in the months ahead as optimism for 2023 takes hold.”

China’s Sector Slump: It’s no ancient secret that Chinese tech stocks—including Alibaba (BABA) and JD.com (JD)—had a nice recent run after getting crushed this year by COVID-19 lockdowns and Beijing’s regulatory crackdown on tech conglomerates. It’s far from clear if the comeback will last, and betting on any particular move by Beijing may not be a risk most U.S. investors want to take. That said, what about U.S. stocks with big exposure to China? It’s a mixed bag. Tesla (TSLA) and Apple (AAPL) struggled over the last month in part from concerns about their China operations. Semiconductor firms like Advanced Micro Devices (AMD) and Nvidia (NVDA) are doing better, but the slate’s far from clean as the United States keeps tough chip sanctions on Beijing. Broadcom (AVGO), another semiconductor firm with big China exposure, could provide an update on the situation when it reports earnings Thursday. The only clear U.S. winner so far from hopes of a Chinese opening appears to be the resort and casino industry. Wynn Resorts (WYNN), for instance, is up nearly 19% over the last month, and Las Vegas Sands (LVS) climbed 17%.

Regions that Roar: The lesson for investors during this Chinese Year of the Tiger is that if you’re looking for exposure to a certain region, it’s not enough to pick the right country; you also have to pick the right sector at the right time. In this case, someone alert enough a month ago to see signs of resolve cracking in Beijing might’ve asked themselves which U.S. companies were poised to benefit. They might’ve written off chips due to those fresh sanctions from President Biden. They might’ve also had worries about AAPL’s past troubles with China’s supply chains. Maybe they would’ve noticed sunny forecasts from travel companies heading into Q4 and put two and two together to focus on stocks that could benefit both from increased travel and Beijing loosening up. Adding all that together, they might’ve settled on resort stocks with big profiles in China like WYNN or LVS, but it would’ve taken focus and research. If there’s a particular region you want exposure to through U.S. companies, it’s a matter of asking the right questions, keeping geopolitics in mind, and paying close attention to what the companies say in their earnings calls. Get all that in place, and you might have the tiger by its tail.

Notable Calendar Items

Dec. 7: October Consumer Credit and expected earnings from Campbell Soup (CPB)

Dec. 8: Expected earnings from Broadcom (AVGO) and Costco (COST)

Dec. 9: November PPI and Preliminary December University of Michigan Consumer Sentiment Index

Dec. 12: November Treasury budget and expected earnings from Oracle (ORCL)

Dec. 13: November CPI, FOMC meeting begins, and expected earnings from ABM Industries (ABM)

Dec. 14: FOMC rate decision, quarterly projections and dot-plot, November Export and Import Prices, and expected earnings from Lennar (LEN)

Dec. 15: November Retail Sales, December Empire State Manufacturing, and November Industrial Production and Capacity Utilization

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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