Quick Retreat: Impressive Thursday Turnaround Halted in Its Tracks Amid Fresh Trade Tiff

(Friday Market Open) The U.S. equities market was on the back foot this morning even before news of a record slump in retail sales.

Sentiment soured after the White House moved to block shipments of semiconductors to Huawei Technologies, once again raising the specter of trade tensions between the world’s two largest economies at a time when more uncertainty seems to be the last thing the market needs.

The editor of an influential Chinese-run publication tweeted that if the United States further blocks key technology supply to Huawei, China would restrict or investigate US companies such as Qualcomm QCOM, Cisco Systems CSCO and Apple AAPL and suspend purchases of Boeing BA aircraft. Shares of those companies were down this morning, as were chipmakers Advanced Micro Devices AMD, NVIDIA NVDA and Skyworks Solutions SWKS.

A question is whether simmering tensions between Washington and Beijing will lead to new tariffs. It seems that what’s old is new again.

In domestic economic data, April retail sales came in much worse than expected, falling by 16.4% when a Briefing.com consensus had expected a decline of 11.9%. The market was expecting a bad number, as the coronavirus forced consumers to cut back on many non-essential purchases. But the scale of the decline was more than expected, adding to fears about the state of the economy during these unprecedented times.

Amid the hit to equities, Wall Street’s main fear gauge, the Cboe Volatility Index (VIX) was up and the yield on the 10-year Treasury was down as investors moved into the relative safety of U.S. government debt

Even without the Huawei and retail sales news, the market could have been in for some selling pressure because of the solid rally yesterday. It seems that investors and traders are prone to take profits, or buy dips, rather quickly in this market because there’s just no telling what the news flow will bring in terms of coronavirus-related health or economic news.

Leadership from the Banks
Thursday’s trading didn’t start off that great for the bulls, with stocks spending a good portion of the session lower after the Labor Department said nearly 3 million people had filed initial claims for unemployment in the week ended May 9. Continuing claims neared a staggering 23 million.

Coming after a day when Federal Reserve Chairman Jerome Powell warned that the economic “path ahead is both highly uncertain and subject to significant downside risks,” it seemed unlikely that there would be much of a rally. But the day proved otherwise.

All three of the major U.S. indices moved from solidly negative territory to close in the green as leadership from the Financials sector helped boost market sentiment.

Financials was the sector leader, advancing more than 2.5%. Some of the sector boost may have come from merger talk, with a Fox Business report saying Goldman Sachs GS may be in the hunt for a strategic tie-up with a major commercial bank. Though no immediate comment was forthcoming, the report—which said Wells Fargo WFC, PNC Financial PNC and US Bancorp USB were the names on the shortlist—helped send the entire sector higher. The rally in Financials also included American Express AXP, Visa V and Capital One Financial Corp. COF, as it seemed investors were more bullish on consumer spending prospects.

And it should be noted that the rally in Financials came on a day when interest rates on Treasuries, which affect how much banks charge in interest, were declining as investors sought the relative safety of U.S. government debt.

The Profit-Taking-Buy-the-Dip Seesaw
In what is perhaps a mirror image of some of the profit-taking we’ve seen drive selling recently, the rally in the banks could be coming because of a buy-the-dip mentality. Even as worries about a premature reopening continue, many in the market seem to be looking toward an economic recovery sparked by states reopening.

But even if that limbo continues, there still may be bargain hunters out there. Because the banks have gotten beaten up recently because of economic worries and the shadow of potentially negative interest rates, investors and traders may have thought Thursday was a good entry point.

That mentality perhaps helped gains in the Financials sector spread to the wider market as investors and traders may have wanted to take advantage of lower equities prices.

Banks weren’t the only bright spot yesterday. Even when the market was at its lowest point, down 2% early Thursday, shares of CSCOwere up 5% on less-bad-than-expected earnings. CSCO may serve as a reminder just how far big tech has outpaced the broader market during the April/May rebound (see chart below).

And oil prices were also able to shrug off the dismal data on jobless claims. Crude prices rose on an International Energy Agency forecast for lower global inventories in the second half of the year. That comes after data showed a decline in U.S. inventories and against a backdrop of rising optimism that the global economic reopening will boost demand for black gold.

Oil prices have been a volatile proxy for economic expectations during the coronavirus pandemic. At one point, a futures contract dipped into negative territory. But oil has rebounded, with the U.S. benchmark now around $30. That’s still a far cry from where prices were before the coronavirus outbreak when prices were roughly double where they are now.

Stocks are in a similar place, having recouped very roughly half of their coronavirus losses but still well off the highs they hit before the outbreak. With the volatility continuing, it seems that we’ve entered a bit of holding pattern in recent days.

One spot to watch on the downside is 2800 in the S&P 500 Index (SPX). Back on Wednesday, despite heavy selling, the 2800 level held up. Should this morning’s selloff extend a bit more, 2800 might be a spot to watch for potential support.

CHART OF THE DAY: SHINY TECH. Though the broad market S&P 500 Index (SPX—purple line) has had a pretty decent rally off the lows set back in March, it's technology that's led the way, with the tech-heavy Nasdaq 100 Index (NDX—candlestick) far outpacing other indices. Data source: S&P Dow Jones Indices, Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

No Man is an Island: Such were the words of John Donne in 1624, and when applied to today's global economy, perhaps they're worth keeping in mind as markets digest the daily ebb and flow. A few years ago, as the U.S. economy looked to be pulling away economically vs. much of the developed world, the question was posed as to whether the U.S. could truly "decouple" from the global economy, considering the current level of interconnectedness. That's a tough sell, which was one reason last year's trade war tended to weigh on the market.

But what about sectors within the same economy? As stocks recouped some of the losses from the March depths, shares of tech companies—and big Comms companies like AmazonAMZN, AlphabetGOOG, FacebookFB and NetflixNFLX that draw heavily on the latest tech—far outpaced the broader market (see chart above). Can tech truly “decouple” from the rest of the market? In order to grow, tech needs the participation from companies involved in all sectors—including the beaten-down Financial, Energy, and Industrial sectors—as they make up a big share of tech customers. And speaking of customers, consumers still make up two-thirds of the economy, and employment trends have been going the wrong way if they’re to be a driver of tech growth. As the economy begins to reopen, it will be important to see if there will be broad-based participation among sectors.

Banks to the Rescue: Thursday’s turnaround in the stock market shows how important leadership from the Financials sector can be. Banks are involved in huge swathes of the economy—from personal savings, to business loans, to home mortgages, to making stock trading possible. By the end of the day yesterday, the Financials sector of S&P 500 Index had a market cap of $4.8 trillion, making it the fourth largest of the 11 sectors in the index. When Financials get on a roll, it seems that the market can’t be stopped.

It seems that those piling into bank stocks on Thursday are thinking the yield curve will steepen, as it would be tough for banks to go much higher without that happening. But at this point it’s worth asking how much of a rise in longer-dated government debt would be enough of a catalyst. The yield on the 10-year Treasury is around 0.6%, and with all the demand for U.S. government debt it seems like it would be amazing if the yield could even get back to 1%. So that leaves the question: Would a more modest rise to 75 basis points be enough to help out the beaten-up banks more? That’s still a very low number historically. 

TD Ameritrade® commentary for educational purposes only. Member SIPC