Heading South: Turnaround Tuesday As Week's Strong Start Fades Following Disappointing China Data

(Tuesday market open) Disappointing data from China and an unexpected rate cut by its central bank renewed worries about the country’s economy, putting Monday’s brief market recovery on ice. Meanwhile, a surprisingly firm U.S. July Retail Sales report renewed concerns about the economy getting too hot, also weighing on stocks.

A warning by Fitch Ratings that it might eventually downgrade large U.S. banks is another stiff breeze blowing down Wall Street this morning, turning financial stocks lower in premarket trading.

Home Depot HD earnings also come into view today. But the top concern is Chinese data, as industrial production and retail sales there failed to meet analysts’ forecasts (see more below). Volatility is on the rise as investors contemplate the heavy news flow.

It’s quite a contrast from Monday, when most major U.S. indexes turned green. Info tech and communications services took pole position and runner-up as semiconductor stocks found their spark and rallied nearly 3%.

Morning rush

• The 10-year Treasury note yield (TNX) rose 4 basis points to 4.22% and is at a new 2023 high.
• The U.S. Dollar Index ($DXY) stepped back slightly to 102.96.
• Cboe Volatility Index® (VIX) futures climbed to 15.91.
• WTI Crude Oil (/CL) fell to $81.65 per barrel.

The U.S. dollar index started the week with solid gains, closing above 103 for the first time since July 6. The strength reflects defensive trading as traders seek perceived “safety,” along with a Japanese yen that’s weakened against dollar since the Bank of Japan (BoJ) adjusted its yield-curve policy in late July. Rising U.S. Treasury yields and recent solid U.S. economic data, including today’s Retail Sales report, also buttressed the greenback.

Just in

China continues to struggle—that’s the message of today’s retail sales and industrial production data. Industrial production climbed 3.7% annually in July, missing the average analyst estimate of 4.4%. Retail sales rose 2.5%, compared with the Trading Economics consensus of 4.5%, a big miss. The People’s Bank of China also trimmed its one-year medium term lending facility by 15 basis points. Most analysts had expected the central bank to stay pat.

While a rate cut might sound bullish, in this case it’s a lesson to investors that they shouldn’t necessarily cheer for lower rates, given that aggressive easing is often done in the context of worsening data.

Worries about China’s economy already were simmering yesterday following news that Tesla (TSLA) cut prices there and that a large real estate developer was suspending trading on its bonds.

Meanwhile, the U.S. economy showed fresh signs of strength early Tuesday as July Retail Sales climbed 0.7% versus the consensus estimate of 0.4%.

The Retail Sales “Control Group” (stripping out food services, auto dealers, building materials, gas stations)—a figure used in the calculation of GDP—rose 1.0% month-over-month, doubling estimates and last month’s downwardly revised gain. It was the largest increase since January.

The takeaway: Consumers appear to remain strong with unemployment at 50-year lows.

Stocks in Spotlight

Home Depot earnings had something for everyone, and the stock wavered in premarket trading. Earnings fell less than feared, and both earnings per share and revenue beat Wall Street’s average estimate. The average ticket rose 0.1%, which is weak but not negative. Pressure on big-ticket items remains a challenge as consumers seem cautious, a company executive told CNBC. However, smaller items moved well in the quarter.

The mixed news from Home Depot might appear to contradict today’s sparking Retail Sales data. However, when you look at the items leading Retail Sales, it’s stuff like e-commerce, restaurants, sporting goods, and clothing, points out Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research. Not things you’d fill your cart with at Home Depot.

Target TGT and Cisco CSCO report tomorrow, with Target before the open and Cisco after the close. We’ll preview Cisco tomorrow morning.

Target’s shares struggled recently after the company disappointed investors with flat sales in Q1. The question is whether low unemployment, rising wages, and stronger consumer confidence helped Target and other retailers this summer. Unlike Walmart WMT, which reports before the open Thursday, Target focuses more on discretionary items and less on staples, though its groceries division performed relatively well in Q1. Target customers generally shrank back from discretionary purchases in early 2023, the company’s executives said in May.

Though this is a busy earnings week, it’s pretty much the last one of the season. That means attention could shift away from company news and toward macroeconomics, especially ahead of the Federal Reserve’s August 24–26 Jackson Hole conference and a speech there by Fed Chairman Jerome Powell.

What to Watch

The data roll on Wednesday with minutes from the last Federal Open Market Committee (FOMC) meeting, along with housing numbers.

Home front: July Housing Starts and Building Permits bow before Wednesday’s open. Analysts see both inching up from June. Consensus for July starts is a seasonally adjusted annual rate of 1.446 million, according to Briefing.com, higher than June’s 1.434 million. Permits are expected at a seasonally adjusted annual rate of 1.46 million, versus 1.44 million in June.

Despite supply constraints, housing starts and permits have trended lower much of the year. Analysts blame rising mortgage rates, which remained stubbornly high in July. Permits, a component of The Conference Board’s Leading Economic Index (LEI), were flat for single-family homes in June but declined for multi-unit buildings.

The multi-unit data are worth watching tomorrow for any sign of a possible rebound that might suggest rising supplies denting rental costs. Rising shelter costs helped swell recent consumer inflation numbers.

Eye on the Fed

Futures trading indicates an 11.5% probability that the Federal Open Market Committee (FOMC) will raise interest rates by 25 basis points next month, according to the CME FedWatch Tool. The probability of rates being 25 basis points higher than they are now after the November meeting is near 40%, up from 30% a week ago. It looks like the market is building in better chances of a pause in September and a hike in November, though it’s still early.

FOMC Minutes on Wednesday afternoon will likely get a close look from investors (see more below).

Recession odds weighed: Despite resilient U.S. economic data, there’s still talk that a formal recession might be ahead. It looks like a close call, write Schwab’s Liz Ann Sonders, Kathy Jones, and Jeffrey Kleintop in the latest Schwab Market Perspective.

CHART OF THE DAY: WEDGE SHOT. The S&P 500 Index (SPX—candlesticks) is now tracking in a very narrow range between technical support at the 4,450 level (red line) where it bumped its head earlier this summer, and resistance above 4,530 near the 20-day moving average. If 4,450 is breached, the 50-day moving average (blue line) sits just under 4,440 and has been a support point for months. Will it hold again? Data source: S&P Dow Jones Indices. Chart source: thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Taking the minutes: One highlight this week is Wednesday afternoon’s release of minutes from the July FOMC meeting, when the FOMC unanimously voted to raise rates by a quarter-point to the current target range of between 5.25% and 5.5%—the highest in more than 20 years. Since then, a handful of FOMC speakers have argued it may be time to pause, fueling expectations of the Fed staying the course in September. There are “plenty of reasons for the Fed to stay on hold the rest of this year,” says Kathy Jones, Schwab’s chief fixed income strategist. “Monetary policy is still tightening, with the Fed’s balance sheet declining and ‘real’ rates climbing. Credit availability through the banking channel is declining. Small- and medium-sized banks are weighed down with commercial real estate problems.”

End game: Now that the Fed is arguably close to ending hikes, attention turns to when it might start cutting. The mantra heard on Wall Street lately is “higher for longer,” and Fed speakers, including Powell, emphasize it would be a mistake to trim rates too soon. That poses the risk of repeating what’s now widely seen as an error in judgment the Fed made more than 40 years ago. Back then, it began slicing rates before inflation had truly run its course. Prices flared and forced more hikes, the economy entered a deep recession, and the Fed lost credibility. History shows that typically there’s about a five-month gap between the final hike and the first cut. That means if the Fed increases rates in November (the futures market puts that probability near 40%), the first cut would be next spring, though there’s no rule that historic trends will repeat. The futures market sees a better than 80% chance of the Fed cutting rates by next May. However, investors have been more dovish than the FOMC, meaning the jury is out on whether the Fed will see enough by May to fetch the scissors.

Five percent club: Small-cap stocks led the way south this month, with the Russell 2000 (RUT) Index now down more than 5% from its July 31 peak and the first major index to roll back 5% since all of them suffered worse losses in March. The broader market is down about 3% since the end of July. Weakness in small-caps can raise worries about U.S. economic health, because smaller companies tend to do most of their business here at home while larger companies are far more likely to sell products overseas. Recent downgrades of U.S. credit and of several regional U.S. banks likely hurt small-caps, implying that these companies might have less access to capital in coming months as banks tighten lending. And while it’s still relatively far off, talk of a possible government shutdown this fall raises concerns about the impact on smaller U.S. companies.

Calendar

Aug. 16: July Housing Starts and Building Permits and expected earnings from Target (TGT) and Cisco (CSCO).

Aug. 17: July Leading Economic Indicators and expected earnings from Walmart (WMT), Applied Materials (AMAT), and Ross Stores (ROSS).

Aug. 18: Expected earnings from Deere (DE) and Estee Lauder (EL).

Aug. 21: Expected earnings from Zoom Video (ZM).

Aug. 22: July Existing Home Sales and expected earnings from Medtronic (MDT), Dick’s Sporting Goods (DKS), Lowe’s (LOW), Macy’s (M), and Toll Brothers (TOL).

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

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