Europe And Russia Continue To Square Off Over Natural Gas

(Thursday Market Open) Equity index futures were mixed ahead of the European Central Bank (ECB) interest rate decision. Dow futures were down more than 100 points, but Nasdaq futures were up about 13 points.

Potential Market Movers

The ECB was expected to raise its key rate by 25 basis points but in the last few days, expectations started to rise to 50 basis points, and that’s what European banks got. The hike was the first for the ECB in 11 years, but the ECB appears to be expecting more hikes as it continues to “normalize” interest rates.

The news pushed the U.S. dollar lower with the U.S. Dollar Index ($DXY) giving up most of yesterday’s gains ahead of the opening bell. The weaker dollar, which has been supporting equities, helped the Dow futures cut its losses and the S&P 500 futures turned slightly positive.  

The U.S. had a couple of poor economic reports this morning. Unemployment claims came in higher than expected for the seventh week in a row and has gotten incrementally higher three weeks in a row.

The Philadelphia Fed Manufacturing Index was much lower than expected with a -12.3 print compared to the forecast of -2.5 and below the previous month of -3.3. Manufacturing in the U.S. saw fewer orders in July and the report saw business conditions worsening inside the Philadelphia, New Jersey, and Delaware region.

Earnings announcements among America’s biggest companies were a little less mixed than yesterday’s reports:

• AT&T T reported better than expected earnings and revenues this morning, but the stock fell more than 5% in premarket action after the company lowered its guidance on ad revenue.
• Philip Morris (PM) also beat on top and bottom line numbers, prompting the stock to rise 4% in premarket trading.  
• Union Pacific UNP topped analysts’ earnings and revenue estimates but traded 0.68% lower before the opening bell as the railroad discussed issues with input and fuel costs.
• D.R. Horton DHI beat on profit but fell short on revenue. It also cut its forward guidance because of a cooling housing market and the expectation of fewer home closings.

After yesterday’s market close, Tesla TSLA rallied on a better-than-expected earnings report despite missing on revenues and reporting lower margins. TSLA climbed 4% in after-hours trading but surrendered most of those gains soon after, perhaps showing that it’s not immune to inflation after all. TSLA has been able to manage higher input costs pretty well up to this point, but now higher prices are catching up.

Tesla may also be facing additional risks with its production facilities in China, which are still dealing with bank protestors. About a week ago we saw protest outside of Chinese rural banks as depositors were demanding to get their money out, but the banks refused. The Chinese government has now stationed tanks outside of banks and is telling depositors that their savings are “investment products” that can’t be withdrawn. The scene appears to be reminiscent of Tiananmen Square for many people when the Chinese government turned tanks on protestor in 1989.

Ford (F) has been trying take some of Tesla’s EV market share and is planning to get leaner to do it. The Detroit giant announced plans to cut 8,000 jobs according to Bloomberg, which said the money saved in salaries will likely help fund Ford’s EV plans.

Looking at commodities action ahead of the open, natural gas futures retreated on the news that Russia will restart its Nord Stream gas pipeline to Europe, and demand in the U.S. had fallen below pre-pandemic levels. On top of that, WTI crude oil futures dropped 3.84% as demand for oil has started slipping and Libya’s oil production is back online and ramping up.

Reviewing the Market Minutes

Europe and energy were in sharp focus on Wednesday. Earlier, Russian energy giant Gazprom said it couldn’t fulfill natural gas contracts with European customers, prompting a swift backlash from the European Union (EU) to reduce natural gas usage by 15% through March. Russia appears to be striking back against EU sanctions by tightening gas exports. The skirmish is intensifying during a European heat wave with a potential repeat of a winter energy shortage that was compounded when Russia’s invaded Ukraine in late February.

Natural gas futures rocketed on the EU news, settling 9.6% higher. The news failed to stretch across the energy complex as crude futures pulled back 0.9% and unleaded gasoline futures dropped 1.2%.

The 10-year Treasury yield (TNX) had moved lower earlier in the session but rose almost two basis points to 3.03% as the natural gas news fueled some fears of further rate hikes. However, the CME FedWatch Tool is still posting a 69.1% probability of a 75-basis-point hike from the Federal Reserve next week.

Stocks traded tentatively higher on the day with the S&P 500® index (SPX) flirting with resistance around the 3,950 level. The bulls made another surge in the last hour of trading pushing the benchmark index to close slightly above resistance at 3,959 to finish with a 0.59% gain for the day.

The Nasdaq ($COMP) led the major indexes, rising 1.58% while the Dow Jones Industrials ($DJI) rose just 0.15%. The Cboe Market Volatility Index (VIX) slid as stocks rose but stayed above its June lows which may reflect some lingering doubts from investors.

Whatever their doubts, investors were able to shrug off the rise in the 10-year Treasury yield in favor of growth stocks. The S&P 500 Pure Growth Index rallied 1.77%, the Consumer Discretionary Select Sector Index climbed 1.64%, and the Technology Select Sector Index increased 1.56%.

Existing home sales came in lower than expected, falling 5.4% month-over-month and down 14.2% year-over-year. However, homebuilders appeared to handle the news well as the S&P Homebuilders Select Industry Index finished with a gain of 0.55%.

CHART OF THE DAY: RISK ON: The Russell 2000 (RUT—candlesticks) was able to break out of the range set by its highs in 2018 and 2020 (shaded area). The RUT could rally to the previous resistance level around 1,925 (yellow line). Rising small-cap stocks is often seen as a sign that investors are willing to take on more risk which can be bullish for the market overall. 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

DOLLAR BENEFACTOR: There has been a lot of discussion around how the strong dollar has negatively affected U.S.-based multinational companies. What doesn’t get a lot of attention is that in the past, a strong dollar has tended to favor small-cap companies because they’re less likely to receive a large portion of their revenues from overseas business. The strong dollar could be one reason why investors are willing to take on the risk of smaller companies, which has driven the Russell 2000 (RUT) up nearly 7.25% in the last five trading sessions.   

RELIEF RALLY: The recent pullback in the U.S. dollar appears to be providing some relief to mega-cap stocks. The CRSP U.S. Mega Cap Index has risen nearly 4.77% over the last five sessions. However, the U.S. Dollar Index ($DXY) is still uptrending despite reports that the ECB was likely to raise rates at its scheduled meeting today. The difference is that the ECB isn’t raising rates at the same pace as the Fed. In fact, no major central bank is keeping pace with the Fed, which means the higher yields in the U.S. are likely to keep the dollar moving higher until the Fed decides to pause.

The FedWatch Tool is forecasting that the Fed is likely to stop raising rates around the first quarter of 2023 and could be cutting rates by June of 2023, which suggests a potential recession. Obviously, these rate hike and cut projections are a long way off, and these probabilities are subject to change, but if and when the Fed starts showing signs of slowing, mega-caps could make a bigger push.

BANK MONITORING: The dollar index compares the value of the dollar against six major currencies including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and the Swiss franc. The euro has the highest weighting in the index making up more than 50%, followed by the yen, pound, loon (Canadian dollar), krona, and franc.

Each of these currencies has a corresponding central bank. What the ECB does will likely affect the index more than any of the other banks, but it’s important to keep an eye on each individual currency especially when the dollar is having such an influence on stocks.

Notable Calendar Items

July 22: Earnings from Verizon VZ, American Express AXP, Schlumberger SLB, and Twitter TWTR

July 25: Earnings from NXP Semiconductors NXPI, and Whirlpool WHR

July 26: New home sales and earnings from Microsoft MSFT, Alphabet GOOGL, Visa V, Coca-Cola KO, McDonald’s MCD, United Parcel Services UPS, and 3M MMM

July 27: Durable goods orders, Pending home sales and earnings from Meta META, Qualcomm QCOM, Rio Tinto RIO, Boeing BA, and Automatic Data Processing ADP

July 28: Gross Domestic Product (GDP) and earnings from Apple AAPL, Amazon AMZN, Mastercard MA, Intel INTC, and Caterpillar CAT

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

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