ECB May Need Bigger Response to Fed After Hot German Inflation Report

(Tuesday Market Open) Equity index futures were pointing to a lower open as investor hesitancy continued ahead of tomorrow’s Federal Open Market Committee (FOMC) interest rate decision.

Potential Market Movers

The FOMC meeting begins today with the spotlight on how high members will raise the overnight rate tomorrow. The 2-year Treasury yield was already up another two basis points before the market open, taking the yield to 3.97%. The 10-year Treasury yield (TNX) was up five basis points to 3.55%.

Before the open housing starts came out much stronger than expected in August, growing 12.2%. Starts were down steeply in July, so the larger August number is likely spillover.

However, the more forward-looking building permits fell 10% for the month, lower than expected. As mortgage rates continue to climb, the future of housing is still in question. Additionally, the yield curve is steepening this morning which could send mortgage rates even higher.  

The steeper curve is helping to push the U.S. Dollar Index ($DXY) higher and adding to investor uncertainty. The Cboe Market Volatility (VIX) rose 3.3% this morning and back above 26.

Looking across the Atlantic, Germany’s Producer Price Index (PPI) came in much hotter than expected in August as inflation grew 1.9% month over month. This was well above the projected 1.6%. The news is likely to put more pressure on the European Central Bank (ECB) to be more aggressive on Thursday in raising their key rate to combat inflation. The ECB is expected to announce their interest rate decision about 14 hours after the Fed announces. The German DAX fell 0.73%.

A few stocks were making moves in the premarket, Ford F issued an earnings warning for Q3 saying that it expects to increase its inventories by just 40,000-to-45,000 units due to the inability to get parts. The stock tumbled 5% on the news.

Cognex CGNX also issued changes to their earnings by guiding their Q3 earnings higher. The stock rose 5.4% ahead of the open.

Change Healthcare CHNG rallied 7.4% ahead of the opening bell after a federal judge denied a request from the U.S. Justice Department to block the merger between Change and United Healthcare UNH.

Reviewing the Market Minutes 

After a negative start, U.S. stocks were able to tick higher yesterday. The S&P 500® index (SPX) rallied 0.63% after bouncing off Friday’s lows.

The Nasdaq ($COMP) also rose from negative territory to close 0.76% higher. The Dow Jones Industrial Average ($DJI) rebounded to a positive 0.64%. However, with the FOMC interest rate decision scheduled for Wednesday afternoon, it’s unlikely stocks will see any real movement until the announcement.

However, the 2-year Treasury yield rose nine basis points to 3.94% its highest level since 2007 and the 10-year Treasury yield (TNX) reached its highest level since 2011 by rising four basis points to 3.49%. The CME FedWatch tool increased the likelihood of a 75-basis-point hike this week by two percentage points to 82%. However, it was calculating an 18% chance the Fed decides to hike the rate 100 points.

The S&P Homebuilders Select Industry Index rallied 1.8% on strength from D.R. Horton (DHI), KB Home (KBH), Lennar (LEN), Meritage (MTH), PulteGroup (PHM), and Toll Brothers (TOL). Each stock was upgraded by KeyBanc Capital Markets.

Apparently, the KeyBanc analysts are seeing something different than the homebuilders because the NAHB Housing Market Index released Monday was lower than expected and in declining territory. But contrarian investors may be seeing value here.

The upgrades in homebuilding shares helped boost the consumer discretionary sector, which finished second to the materials sector on the day. The real estate sector—made up mainly of REITS—and the health care sector were the only two to finish the day in the red. 

CHART OF THE DAY: The Real Estate Select Sector Index ($IXRE—candlesticks) has underperformed the broader the S&P 500 (SPX—pink) over the previous 12 months, declining nearly 13.35%. The real estate index has recently lost in relative strength (green) against the S&P 500 too. The chart suggests that real estate is losing momentum. Data Sources: ICE, S&P Dow Jones Indices. Chart source: the thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

GRADING STOCKS: Stock analysts are getting increasingly bearish on the economy. According to FactSet, buy ratings peaked in February at 57.4%. By mid-September, that number had fallen to nearly 55%. The energy sector has the highest number of buy ratings with 63%, followed by technology at 62%, and real estate at 62%. Consumer staples (39%) and utilities (49%) have the lowest number of buy ratings.

Despite the high number of buy ratings for energy stocks, analysts are growing less bullish on them with the number of buy ratings falling from 68% to 63%. However, real estate is garnering an increasing number of buys, climbing from 55% to 62%.  

OUTLOOK REVISIONS: Positive earnings revisions tend to precede or coincide with rising stock prices. Therefore, seeking out positive earnings revisions can help investors find potential investment candidates. Data from Yardeni Research shows that analysts looking toward 2023 are forecasting higher earnings for the S&P 500 energy, utilities, and real estate sectors, though real estate has recently slowed. All other sectors were seeing negative revisions as of September 9.

Through the remainder of 2022, the data shows that energy, real estate, and materials are the only sectors likely to maintain positive revisions.

Investors can expect another round of revisions to appear around the second week of October just before the Q3 earnings season kicks off.

ENVISIONING REVISIONS: Recently, overall earnings revisions in the U.S. have turned negative since global positive revisions peaked in 2021. However, Yardeni Research shows that overall Europe is still positive.

Many companies in smaller or less-developed countries that were relatively big oil producers over the last year are showing positive earnings revisions. These include firms in countries like Denmark, Finland, Mexico, Norway, Russia, and Spain. However, as their success is likely reliant upon the performance of oil prices, investors looking for international diversification may want to consider these choices carefully.

Notable Calendar Items

Sep 21: Existing home sales, FOMC interest rate decision and Federal Reserve Chairman Powell’s press conference followed by earnings from General Mills (GIS), Lennar (LEN), H.B. Fuller (FUL), and KB Home (KBH)

Sep 22: Earnings from Costco (COST), Accenture (ACN), FedEx (FDX), FactSet Research (FDS), and Darden Restaurants (DRI)

Sep 27: Durable goods orders, CB consumer confidence, New home sales and earnings from Cintas (CTAS), Jabil Circuit (JBL), BlackBerry (BB), Cal-Maine Foods (CALM), and Cracker Barrel (CBRL)

Sep 28: Pending home sales and earnings from Paychex (PAYX)

Sep 29: Gross Domestic Product (GDP) and earnings from Nike (NKE), Micron (MU), CarMax (KMX), Carnival (CCL), and Bed Bath & Beyond (BBBY)

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

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