Shutdown Avoided? Stocks Get Early Boost With Activision Blizzard Earnings Later

Conventional wisdom suggests that government shutdowns don’t matter much to the markets. That proposition might get tested Tuesday.

U.S. stock indices turned a bright shade of green after news of a potential border deal in Congress to avoid a shutdown that could start this Saturday. While the recent record-long shutdown coincided with a rally on Wall Street, investors tend to dislike uncertainty. The potential for another shutdown is just one of the uncertainties at this point, a many-headed monster that also includes Brexit, China trade, and the government debt ceiling.

The shutdown showdown is still fluid, with moving parts. Both houses of Congress need to approve the deal and the president needs to sign it, all by Friday. Still, the potential for even one of the overhangs to drop out of the picture appeared to provide some relief early Tuesday. 

Even if the shutdown gets avoided, where stocks go next arguably comes down to the tariff situation. The conclusion of that could get us back to a market trading more along the lines of what investors typically care about, but right now the trade issue hogs a lot of the scenery. Things could come to a great conclusion and set off a rally, or the opposite could happen. There’s a sense that everyone is waiting for a press conference any of these days that all this might ride on. At this point, there’s no negative news out of China, and no news is arguably good news in that situation.

Remember what’s at stake with China. If the two countries can’t come to terms by the beginning of March, U.S. tariffs on $200 billion worth of China-made goods could increase to 25% from 10%. Some of the multinational companies scheduled to report earnings this week, including Cisco Systems, Inc. CSCO and Deere & Company DE, could potentially provide insight into what impact those higher tariffs might have on their operations.

Speaking of earnings, this morning featured better than expected results from Under Armour Inc UAA, which beat third-party consensus on both earnings and revenue and reaffirmed guidance. Shares initially rose about 2% in pre-market trading, but then turned negative. Activision Blizzard, Inc. ATVI reports this afternoon, followed Wednesday morning by Hilton Hotels Corporation HLT. There’s also some inflation data ahead (see more below), and Michigan sentiment looms Friday. 

Meanwhile, crude prices were finding some strength, up about 2% early Tuesday, as OPEC said it cut crude output by about 800,000 barrels per day in January to about 30.8 million barrels per day. The oil cartel had said it would cut back to try to reduce an excess supply. After a sharp fall late last year, crude oil prices are up about 15% so far in 2019.

In Europe, stocks rose early Tuesday, drawing some of their strength from a positive earnings report out of tire maker Michelin.

Climbing Yields No Relief for Big Banks

A bit of a dichotomy seemed to develop Monday as Treasury yields crept slightly higher even while the stock market struggled to hold early gains and finished mixed. Often, a weaker Treasury market (yields rise when bond prices fall) can mean strength in the financial sector, but it’s hard to argue that case looking at Monday’s action. Yes, financial stocks finished higher, but many of the biggest bank stocks finished flat to lower.

If bonds are down and rates are higher but financials can’t find traction, that might be cause for concern going forward. The sector’s price-to-earnings ratio is pretty low from a historic basis, but investors who’ve entered bank stocks over the last few months thinking they might benefit from low P/Es haven’t really seen those investments pay off that much. 

One thing that might give the sector some spark is mergers, and there were media reports Monday that WisdomTree Investments WETF had explored a sale to JPMorgan Chase & Co JPM last year. The two companies couldn’t agree on a price, Bloomberg said, and WETF isn’t seeking a buyer now.

Still, we saw two mid-size banks—BB&T Corporation BBT and SunTrust Banks, Inc. STI—merge last week, and the development of technology for the financials sector seems like a hot trend that maybe could mean more mergers and acquisition (M&A) activity. Since there’s probably nothing that can spark the sector from a rate standpoint at least until June and perhaps longer—considering the Fed’s hands-off stance—one possibility is that M&A activity could continue to happen in the financial space and set off some interest. We’ll have to wait and see. 

Small-Caps, Big Gains

Another dichotomy that seemed to show up Monday was between large-cap and small-cap stocks. The Dow Jones Industrial Average ($DJI) was the only major index to fall for the session, while the Russell 2000 (RUT) small-cap index gained more than 0.8% and continues to be on a roll. The RUT is up more than 12% year to date, easily surpassing the 7.4% $DJI gain since the start of January. One school of thought suggests that, as we saw last spring, some investors are embracing small-caps because they tend to be companies with less exposure to foreign market. That means they might have less risk from a trade standpoint if talks with China head south. 

The RUT also started from further back than the $DJI, having lost more ground over the last few months. Since Sept. 30, the RUT is down 9% while the $DJI is down 6%. So maybe the thinking is that the RUT started to look a bit cheaper than some of the larger-cap indices.

Looking at sector performance to start the week, there was strength in some of the cyclicals including energy and industrials. Financials actually came in third on the list, while communication services had the Street’s worst day. Most of the “FAANG” stocks, including Netflix, Inc. NFLX and Facebook, Inc. FB, lost ground.

Risk On or Off? It’s Hard to Tell

Dichotomy seemed to be the word of the day on Monday, not only in the financial sector and the small cap/large cap trade, but in the global macroeconomic picture as well. The U.S. dollar often catches a bid when the risk meter rises. The same can be said for the Cboe Volatility Index (VIX). Yet the VIX has been softening over the past few weeks, even as the U.S. Dollar Index ($DXY) rallied. The greenback is currently riding an 8-day win streak, which has taken it from the low 95-handle to above 97 Monday (see figure 1 below). Meanwhile, both gold (/GC) and crude oil (/CL) have retreated from recent highs (until oil and gold rallied early Tuesday). Some indicators seem to be flashing “risk-on” even as others toggle to “off.” 

Perhaps the answer lies across the Atlantic, where macroeconomic risks do appear to be elevated. On Friday, the yield on the German 10-year Bund ticked below 0.01%—all the way to 0.0077%—for the first time since 2017. This after Germany’s GDP reading came in at its lowest level since 2013. Meanwhile, ahead of another looming Brexit deadline, Britain released data showing its economy grew at its slowest pace since 2012 last year. 

So maybe there’s a bit of risk-on sentiment here in the U.S. as some overseas markets had gone the other way. The potential resolution of the government shutdown also might play into the risk meter swinging to “risk-on” overnight. We’ll have to wait and see whether the dichotomy can continue amid globally-intertwined markets. A dovish Fed arguably has the potential to put some vigor back into gold and other commodities, since monetary policy at this point favors a weaker dollar and with a weaker dollar, commodities often tend to get a boost.

Figure 1: IS THIS THING ON OR OFF? The Cboe Volatility Index (VIX - candlestick) has eased off recent highs, while the U.S. Dollar Index ($DXY - purple line) rides an 8-day win streak. This seems to be part of the dichotomy between some traditionally risk-on and risk-off asset classes. Data source: Cboe Global Markets, ICE. The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Prices Inching Up?: Consumer prices likely rose just 0.1% in January, according to consensus projections ahead of the data from Briefing.com. The report is due tomorrow morning, followed by producer prices on Thursday. While the overall consumer price index (CPI) might rise only a smidgen in part because of soft gasoline prices, core CPI that strips out energy and food could climb 0.2%, Briefing.com’s consensus reading showed. Often with these reports, it’s the year-over-year comparisons that steal the show. Back in December, CPI rose 1.9% year over year, down from 2.2% in November. Core CPI rose 2.2% year over year. 

If January’s readings turn out similar, that might support those who argue the Fed could continue its policy of patience with rates. The Fed has said its aim is for inflation of around 2%, but the main inflation meter it watches comes early next month when the personal consumption expenditures (PCE) data bows. That indicator rose 1.8% year over year in November, arguably a relatively benign reading.

Those Shrinking Tax Refunds: Even if prices didn’t rise much over the last year, consumer spending potentially has another hill to climb: Smaller tax refunds. Though this probably won’t show up in January’s retail sales data, due later this week, it could possibly weigh on future retail sales numbers depending on how consumers react

While most Americans received a tax cut last year, the average tax refund so far this year is down 8%, or around $170, The Wall Street Journal said. The number of people receiving a refund has dropped by about a quarter. That still could change over time as more refunds get processed, according to the government. The jury is out on whether smaller refunds would actually have much impact on consumer spending. A survey reported on by CNBC last year found that more than 40% of respondents planned to sock away their refunds in the bank, while another one-third said they’d use refunds to pay down debt. Only 10% said they’d use the money for a vacation, and five percent said they’d make a major purchase with the extra cash.

Toying With The Market: Toy and video game makers took top billing on the earnings show late last week. On Thursday, video game companies Take-Two Interactive Software, Inc TTWO, Electronic Arts Inc. EA and Activision Blizzard all dipped by more than double digits on disappointing forecasts from EA and TTWO. Then on Friday, shares of Mattel, Inc. MAT leapfrogged more than 23% after the company beat third-party consensus earnings and revenue estimates. MAT’s quarter might look surprisingly strong considering the loss of distributor Toys ‘R Us, whose liquidation about a year ago appeared to weigh on MAT’s stock in 2018, according to analysts. Apparently, however, the company found new ways to sell its big brands of popular dolls and toy cars, which both saw double-digit constant currency growth in Q4. Still, net sales did fall year over year, which the company blamed partly on the Toys ‘R Us liquidation.

Toy sellers like MAT and also video game companies, to some extent, could face a demographics issue in coming years. Children aged 0-14 accounted for 19% of the U.S. population in 2015, but that’s expected to fall to 17% by 2035 as the population of people aged 65 and older increases, according to The Toy Association, a trade group. The population of young people is still growing, but will climb just 2.4% total between 2015 and 2025. The size of the global toy market rose 15% between 2012 and 2017, The Toy Association said, but U.S. toy sales rose just 2% year over year in 2017.

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