A Strong Dollar And Looming CPI Report Appear To Be Unsettling Investors

(Tuesday Market Open) Equity index futures were falling once again ahead of the opening bell as recession fears pushed the Cboe Market Volatility Index (VIX) up 3% to the 27 level and WTI crude oil futures tumbled 4.68%. 

Potential Market Movers

Global recession fears grew with news out of Germany that its ZEW Economic Sentiment Index fell to -53.8 in July—well below analyst’s estimates of -38. This number fell severely from June’s -28 level and now stands as the lowest reading since December 2011. Questions over the country’s energy supplies appear to be driving the negative outlook. The German DAX was down 0.76% overnight.

Investors appear to be favoring Treasuries as a safe haven from the rising possibility of a global recession. The 10-year Treasury yield (TNX) fell five basis points to 2.94% and bond prices rose. The 2-year Treasury yield remains higher than the 10-year at 3.04%, keeping the 2s10s spread inverted for nearly a week and further fueling recession fears.

However, concerns that investors are feeling are not new. They’re the same ones we’ve been discussing for some time fueled by continuing Chinese lockdowns, strength in the dollar, and rising inflation signals from months of government reports. When tomorrow’s Consumer Price Index (CPI) gets out of the way as earnings season gets into the full swing, investors should have more information to work with and the ability to focus on domestic markets.

In fact, a few earnings themes are surfacing already. While many consider Thursday as the start of earnings season, 4% of the S&P 500 (SPX) has already reported this month, according to FactSet. So far FactSet has observed that labor costs and shortages have been the top terms mentioned in earnings conference calls with supply chain disruptions, transport and freight costs, Russia and Ukraine, and foreign exchange or currencies round out the top topics. These themes will likely persist throughout the earnings season.  

Speaking of earnings, before the market open PepsiCo (PEP) reported beats on earnings and revenue estimates causing the stock to pop up 1%. Perhaps PEP will set the tone for the rest of the consumer staples sector earnings ahead.

In other stock news, Peloton (PTON) was surging 5.27% higher in premarket action on the news that it’s outsourcing bike production and simplifying its supply chain. The move is expected to be a big cost saver for the company. 

Reviewing the Market Minutes

The stock market fell Monday as investors await Wednesday’s Consumer Price Index (CPI) report one day ahead the unofficial start to Q2 earnings season. Stocks felt immediate pressure from the rising dollar, driving the S&P 500 futures lower before the opening bell. By the end of the day, the U.S. Dollar Index ($DXY) finished 1.13% higher and the EUR/USD spot pair were fractions of a cent away from parity.

The dollar strengthened as the European and Chinese economies continued to show weakness. The Europe Stoxx 600 fell 0.50%, led by the German DAX sliding 1.4%. The Hong Kong Hang Seng plunged 2.77% and the Shanghai composite tumbled 1.27%.

China seemed to have nothing but bad news as Macao shut down its casinos for a week to battle new cases of COVID-19, government authorities put down a protest in the central Henan province after a run on banks, and more real estate developers struggled to make bond payments.

In the U.S., the tech-heavy Nasdaq ($COMP) led U.S. stocks lower, falling 2.26% because so many of its companies have production facilities in China wrestling the lockdowns. The S&P 500 (SPX) and the Dow Jones Industrials ($DJI) fell 1.15% and 0.52% respectively during the day.

Wynn Resorts (WYNN) and Las Vegas Sands (LVS) plummeted more than 6% each as their Macao properties will be shuttered for a week.

The 10-year Treasury yield (TNX) fell back below 3% to close at 2.99%. For yet another day, the 2s10s spread remained inverted with the 2-year Treasury yield settling at 3.06%.

Energy futures were mixed as WTI crude oil futures settled 1.3% lower to $103.74 per barrel. Natural gas futures rose 5.9% at settlement. Unleaded gasoline futures settled just 0.2% higher on the trading session.

CHART OF THE DAY: INVERSION. The relationship between the U.S. Dollar Index ($DXY—candlesticks) and the S&P 500 (SPX—pink) inverted after March of 2020. The two indexes were mostly inversely correlated over the next year. The correlation line (red) calculates the correlation coefficient. If it’s at or near zero, there is no correlation, but as it becomes increasingly negative, the indexes are inversely correlated. 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

Correlation & Causation: A favorite line of statisticians, or people who may not like what the stats might tell them, is that “correlation is not causation.” While causation is often difficult to prove, we can see in the chart above that there is at least some kind of a relationship here between bold movements in the U.S. dollar and the stock performance of multinational companies.

Data from Morgan Stanley (MS) and Refinitiv indicates that on a year-over-year basis, every percentage point gain in the dollar results in about a half point hit to earnings on the S&P 500 (SPX). With the dollar rising about 16% over the last 12 months, S&P 500 earnings have faced an 8% wallop.

Mega Problems: One problem that the S&P 500 (SPX) has is that it’s still weighted heavily with some major mega-cap multinational companies. Alphabet (NASDAQ: GOOG), Amazon AMZN, Apple (NASDAQ: AAPL), Meta (NASDAQ: META), Microsoft (NYSE: MSFT), and Netflix (NASDAQ: NFLX) make up 20.1% of the S&P 500’s market cap. Many of these companies have already issued currency headwind warnings, which are likely acting as a drag on the entire index. For example, Statista Research found that in 2021, about 54% of Alphabet’s revenue was generated outside the United States.

However, the issue is much broader than these six companies. In today’s globalized world, every company in the S&P 500 has a presence abroad or does business overseas which means every company will have currency headwinds to some extent.

Changing Grades: According to Briefing.com, right after yesterday’s market close, 18 companies were listed as analyst upgrades while 43 companies were downgraded. Up until this week, many investors have been wondering why there were so few downgrades as analysts appeared to be remarkably bullish going into an earnings season with higher interest rates, high inflation, recession fears and many more disruptions aside affecting global markets. It’s likely that over the next few days, we’ll see an influx of downgrades as analysts get their ratings out before earnings season kicks off later this week.

Notable Calendar Items

July 13: June Consumer Price Index (CPI) and earnings from Progressive PGR, Fastenal FAST, and Delta Air Lines DAL

July 14: Producer Price Index (PPI) and earnings from Taiwan Semiconductor TSM, JPMorgan Chase JPM, Morgan Stanley MS, Cintas CTAS, and ConAgra CAG

July 15: Retail sales, preliminary University of Michigan consumer sentiment, and earnings from UnitedHealth UNH, Wells Fargo WFC, BlackRock BLK, Citigroup C, and U.S. Bank USB.

July 18: Earnings from Bank of America BAC, IBM IBM, and Goldman Sachs GS

July 19: Building permits, Housing starts, and earnings from Johnson & Johnson JNJ, Lockheed Martin LMT, Netflix NFLX, Haliburton HAL, JB Hunt JBHT, and Hasbro (HAS)

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

Image sourced from Shutterstock

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