Back for Another Round: Rate Hike Fears Grow After Strong Retail Sales Sends Yields Spinning Higher

(Tuesday market open) Early earnings results continued to impress but major indexes flagged in premarket trading Tuesday as Treasury yields swung higher after unexpectedly strong September U.S. Retail Sales raised concerns about another possible rate hike.

Earnings from Goldman Sachs GS, Bank of America BAC, and Johnson & Johnson JNJ this morning blew past Wall Street’s average expectations. At the same time, the U.S. 10-year Treasury note yield climbed nine basis points to 4.8% and is knocking on the door of 16-year highs recorded earlier this month that followed a solid September jobs report.

Major indexes fought their way higher on Monday despite rising Treasury yields, though Wall Street remains on edge amid worries about the Middle East. Every S&P 500 sector rose yesterday, though so-called “cyclical sectors” including consumer discretionary, industrials, and communication services, led the way.

“A number of areas that sold off sharply last week rallied yesterday, but rising yields are the pain point today,” says Kevin Gordon, senior investment strategist at Schwab. “Retail led in consumer discretionary after struggling over the past month.”

Speaking of retail, today’s Retail Sales report showed 0.7% monthly growth last month versus analysts’ expectations for 0.3%, and August’s report saw an upward revision. The benchmark U.S.10-year Treasury note yield added to gains after the data release.

Morning rush

• The 10-year Treasury note yield (TNX) rose 9 basis points to 4.8%.
• The U.S. Dollar Index ($DXY) is steady at 106.25.
• Cboe Volatility Index® (VIX) futures increased slightly to 17.68.
• WTI Crude Oil (/CL) fell to $86.87 per barrel.

Just in

Retail sales rose 0.6% excluding automobiles. And control group retail sales, which is stripped down to take out more volatile components and factors into the calculation of Gross Domestic Product (GDP), rose 0.6%.

Monthly retail sales fell four out of five months late last year and in early 2023, but they haven’t been negative since March. Today’s report hints that consumers remain healthy, perhaps due to low unemployment. However, major indexes slipped further after the data, implying that investors see good news as bad for the interest-rate picture. The futures market now builds in nearly 40% chances of a rate hike before the end of the year, up from around 33% before the Retail Sales report.

Bank boost: Financial earnings keep surpassing analysts’ expectations. Bank of America shares got an early boost in premarket trading, but Goldman Sachs shares fell slightly.

• Net interest income, or the money banks make lending minus what they pay to customers, continued to buttress both Bank of America and the big banks that reported last Friday—the boost from that has lasted longer than many analysts anticipated. Bank of America raised its provision for credit losses, or the money it puts aside in case of loans going bad, by $336 million to $1.2 billion in Q3, a sign that conditions remain difficult partly because of high interest rates.
• The story was positive in a different way at Goldman Sachs, which surpassed top- and bottom-line expectations thanks in part to a solid performance by its Global Banking and Markets division. Fixed income, currencies, and commodities trading boosted Q3 results there, the company said. However, investment banking fees were nearly unchanged from a year ago, a sign of the tough environment for Wall Street dealmaking.
• Johnson & Johnson beat analysts’ forecasts and raised guidance in the company’s first full quarter after spinning off its Consumer Health division. Shares rose more than 1% in premarket trading. During the earnings call today, investors may want to listen for updates on lawsuits it faces over its talc products, including baby powder. Another concern executives might address is possible struggles for the company’s bariatric surgery products due to the growing popularity of anti-obesity drugs.
• Separately, Lockheed Martin LMT shares lost ground in premarket trading despite beating earnings expectations. War in the Middle East gave defense industry stocks, including Lockheed Martin, a tailwind recently, and the company might address that on its call. It reaffirmed previous guidance, and perhaps that’s one reason shares slipped. Investors might have been hoping for a guidance hike.

What to watch

Doors open first thing Wednesday for September Housing Starts and Building Permits. Analysts expect a moderate monthly increase in starts to an annually adjusted rate of 1.38 million, and a small decrease in permits to an annually adjusted 1.45 million, according to Briefing.com. Permits are among the leading economic indicators and rose sharply in August. The question is whether that’s the start of a trend. Rising permits might lead to more housing construction, which in turn could help make homes more affordable in a market where supplies are constrained.

Stocks in spotlight

Research firm FactSet sees 0.4% S&P 500 earnings growth in Q3. That would make Q3 the first quarter of year-over-year earnings growth since Q3 2022. About 6% of companies have reported, with another 10% scheduled for this week. Through Monday, 33 of 500 S&P companies have reported results. Of those, 88% beat analysts’ bottom-line estimates.

Tomorrow afternoon brings Tesla TSLA and Netflix NFLX, two of the most closely watched “mega-cap” stocks. Their results could have an outsized impact on the overall market due to their heavy market capitalizations.

Downstream: Earnings from Netflix (NFLX) follow recent negative notes from analysts. Some warn that 2024 growth could fall short of expectations, while others worry about the company’s ability to expand margins. Subscribership growth is pegged at 6 million for Q3, Barron’s reports. Shares remain up year-to-date but well below the summer peak.

The company missed Wall Street’s Q2 revenue expectations even as subscribership rose 8%. One question is how long it might take for the company’s crackdown on password-sharing and its ad-supported streaming venture to improve bottom-line growth.

Earlier this month, Tesla reported Q3 production of 430,000 vehicles and delivery of 435,000 vehicles and said a sequential drop in volume was caused by planned downtime for factory upgrades. Tesla shares have chopped around the last couple of months after charging higher last spring.

United Airlines UAL and American Airlines AAL both report this week, along with CSX CSX and Union Pacific UNP. The Dow Jones Transportation Average ($DJT) is down 10% from its late-July peak, a worse performance than the S&P 500® Index (SPX). Transport stocks like airlines, railroads, trucking, and shipping companies are often viewed as helpful barometers for consumer and business demand, and softness there sometimes translates into broader market weakness over time.

Eye on the Fed

Early today, the probability that the Federal Open Market Committee (FOMC) will raise its benchmark funds rate from its current 5.25% to 5.50% target range following its October 31–November 1 meeting was 10%, according to the CME FedWatch Tool. Odds that rates could be a quarter-point higher coming out of the December 12–13 meeting were about 40%.

Beyond the headlines: Recent resilient data say one thing about the economy, but the real story lies below the surface. Schwab’s top experts help you get the full picture in their latest Schwab Market Perspective.

CHART OF THE DAY:  LOW BAROMETER. Two indicators that investors often see as economic barometers showed resilience recently but still lag the broader market. Small-cap stocks (RUT-candlesticks) and the Dow Jones Transportation Average ($DJT-purple line) are worth watching to see if they can add to light gains. Data sources: S&P Dow Jones Indices, FTSE Russell.  Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

China break: U.S. data and earnings dominate the week, but investors might want to watch China as well. That’s especially true tonight, U.S. time, when Beijing issues a host of economic numbers, including Q3 GDP, Industrial Production, and Retail Sales. “China’s Q3 GDP may miss the 5% full year target, but new fiscal stimulus may be on tap,” says Michelle Gibley, director of international research at the Schwab Center for Financial Research. “Additionally, data for the month of September is showing some improvement.” China delivered some stimulus over the weekend, injecting additional liquidity through its medium-term lending facility. However, worries about the property market remain front and center, with a major property developer possibly on the verge of default. “The property market has seen some benefit from cuts to downpayment ratios and interest rates, but the recovery is likely to be drawn out and bumpy,” Gibley adds. “Investors may need to get used to slower growth for longer in China, taking a longer-term view and being diversified when investing in emerging markets.”

Getting wordy: It’s almost as if policymakers want to say as much as possible before the pre-FOMC meeting “quiet period” begins this Friday. This week’s packed schedule of Fed speakers could create choppiness in an already volatile environment. The crown jewel is at noon ET on Thursday when Fed Chairman Jerome Powell participates in a panel discussion on the economic outlook. Powell’s words aren’t necessarily worth parsing for hints about the Fed’s next move. A November pause seems relatively likely based on the futures market indicating low chances of a hike. Instead, key takeaways could be what Powell says about recent firm inflation and jobs data, especially consumer inflation expectations ticking up in two separate reports. Will Powell reinforce ideas of a “soft landing” for the economy even as rates remain higher for longer and inflation doesn’t appear fully tamed? It’ll also be interesting if he discusses the impact of higher rates on many companies that need to refinance.

Talking technicals: The 100-day and 50-day simple moving averages (SMA) for the SPX are both just above 4,400. The index hasn’t closed at 4,400 or above in nearly a month, but it also hasn’t closed below 4,300 since October 5, trading in a relatively narrow range. “A close above 4,400 would be a bullish development, getting back above the 50- and 100-day SMA, followed by 4,500-4,515—which is where we sold off in early September,” says Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research. “In the meantime, we’re still in a downtrend since August, so we have to take it one constructive technical step at a time.”

Calendar

Oct. 18: September Housing Starts and Building Permits, and expected earnings from Abbott Labs (ABT), Morgan Stanley (MS), Procter & Gamble (PG), Travelers (TRV), Netflix (NFLX), and Tesla (TSLA).

Oct. 19: Initial Jobless Claims, September Existing Home Sales, September Leading Economic Indicators, and expected earnings from American Airlines (AAL), AT&T (T), Philip Morris (PM), Union Pacific (UNP), and CSX (CSX).

Oct. 20: Expected earnings from American Express (AXP) and Regions Financial (RF).

Oct. 23: Expected earnings from Whirlpool (WHR).

Oct. 24: Expected earnings from Archer Daniels (ADM), Coca-Cola (KO), 3M (MMM), General Electric (GE), General Motors (GM), Verizon (VZ), Texas Instruments (TXN), and Visa (V).

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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