Cisco, Walmart Earnings Brighten Market Sentiment Even As U.S. Targets Huawei

Although trade tensions continued to concern market participants Thursday morning, corporate earnings appeared to have more sway over sentiment in a development that shows equities may have reached a new equilibrium after strong selling pressure.

On the corporate earnings front, Cisco Systems, Inc. CSCO beat expectations on its top and bottom lines and issued better-than-forecast revenue guidance. The company sees “very minimal impact” from tariffs as it has been working to adjust its supply chain and only about 3% of the company’s revenue comes from the Asian nation. Shares were up more than 3% early Thursday. 

Meanwhile, Walmart Inc WMT, up more than 3% in premarket trade Thursday, reported earnings that topped analyst expectations as U.S. same store sales also beat forecasts. The results form a bright spot for the U.S. consumer a day after data showed U.S. retail sales were lower than expected. Walmart also told Reuters that rising tariffs will make goods more expensive for shoppers, but the company says it’s working on ways to mitigate the price rises.

The companies’ comments illustrate how the trade war between the world’s two largest economies is affecting companies and customers, as investors have worried about the spat disrupting supply chains and making goods more expensive, potentially damaging demand.

But this morning, a swing in equity index futures from negative to positive on the good vibes from the earnings illustrates how the market seems to have come to terms with a “new normal” after the United States raised tariffs on $200 billion of Chinese goods, and China, in retaliation, announced increased tariffs on U.S. goods are scheduled to start in June.

Still, it’s arguable that stocks would be poised for larger gains this morning if fresh tensions between the U.S. and China hadn’t surfaced. President Trump signed an executive order saying U.S. firms can’t use telecom equipment from companies that pose a national security risk. And the Commerce Department added Huawei Technologies to a list requiring the Chinese-telecom company get government approval to acquire components and technology from U.S. firms.

In other news early Thursday, housing starts rose 5.7% in April as construction on new homes hit an annual rate of 1.24 million, according to the latest data from the U.S. Commerce Department. That’s more than the 1.21 million annual rate economists expected. The news seems to bode well for homebuilders as the housing market has been struggling to find its footing amid rising home prices that have kept many buyers out of the market. However, keep in mind that the increase was still below last year’s despite lower mortgage rates.

Another Turnaround

U.S. stocks on Wednesday opened in the red but erased their losses to end in positive territory as the market got some good news on the tariff front for a change.

According to media reports, the Trump administration has decided to delay a decision about imposing auto tariffs. The move punts the decision on duties that would likely have affected auto imports from the European Union and Japan and delays the possibility of another escalation in global trade tensions, keeping the main front between the United States and China.

In other relatively good news on trade, Treasury Secretary Steven Mnuchin told U.S. lawmakers that he expects to continue trade talks in Beijing in the near future. He also said the United States is near to an understanding on removing duties on Canadian and Mexican steel and aluminum.

Data Doesn’t Inspire Confidence

Earlier in the day, equities had been lower amid data pointing to slower economic growth.

Chinese data showed growth in retail sales and industrial output was lower than had been expected, adding data points to existing worry about the world’s second largest economy amid the trade dispute with the United States. 

Retail sales didn’t look so great in the United States either, and industrial production also disappointed. For retail sales, data showed a drop of 0.2% in April when a Briefing.com consensus had forecast a 0.2% rise. Meanwhile, industrial production in the same month fell 0.5% versus expectations of a 0.1% gain.

The U.S. consumer makes up the biggest single contributor to the nation’s gross domestic product, so a dip in retail sales could be a worrisome sign, especially given all the concerns about the global economy emanating from the trade war. 

Sector Highs and Lows

The tech heavy Nasdaq Composite (COMP) substantially outpaced the other two main U.S. indices, helped by gains in Alphabet Inc GOOG, Netflix, Inc. NFLX and Facebook, Inc. FB, which also helped boost the S&P 500 Communication Services sector more than 2.1%, making it the day’s biggest sector winner.

On the other end of the spectrum, the Financials sector ended in the red, pressured by lower Treasury yields. Demand for U.S. government debt was higher after the tepid China and U.S. data. Lower long term yields make it harder for banks to earn money when they have to pay out more interest on deposits relative to interest they earn on loans. Of note, the recent downturn in the 10-year yield has put it back below the 3-month rate—a yield inversion than many perceive to be a recessionary sign.  

It’s notable that the yield on the benchmark 10-year Treasury didn’t pare much of its losses as stocks moved into the green (see figure 1 below). Normally you might expect that as higher risk tolerance spurred buying in equities, investors might move money out of bonds, raising yields, which move inversely to prices.

The breakdown in that traditional relationship could signal that bond-market investors aren’t putting as much faith in the reviving trade-related optimism as are participants in the stock market. That could be a warning sign that recent gains in equities could be fragile.

On the other hand, Wall Street’s main fear gauge, the Cboe Volatility Index (VIX) fell nearly 9% to 16.44, indicating some market participants are getting more comfortable than they were earlier in the week when the VIX was above 20. We’ll have to wait and see which indicator proves the more accurate for the stock market – the volatility gauge or the bond market. 

FIGURE 1: STOCKS AND BONDS. Despite the rally in stocks, U.S. government debt remained in demand Wednesday. The benchmark 10-year Treasury yield stayed lower all day even as equities erased early losses. The lower yield helped pressure Financials sector shares.Data source: S&P Dow Jones Indices, Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

GDP Forecast Dims: The disappointing U.S. retail and industrial data helped shave a good bit off the Atlanta Fed’s latest forecast for Q2 2019 gross domestic product in the nation. Its GDPNow forecast dipped to 1.1% Wednesday from 1.6% on May 9 after data on retail sales and industrial production came in weaker than expected. As Briefing.com put it in commentary about the retail sales number: “The key takeaway from the report is that consumers curtailed discretionary spending on goods in April in a way that will temper the outlook for Q2 GDP growth.”

Tariffs Raising Inflation Outlook: Goldman Sachs Group Inc GS has raised its estimates of the inflationary effect of tariffs, saying that U.S businesses and households have born the entirety of the costs of the duties. The bank, in a recent note, cited evidence from two academic studies that showed Chinese exporters of tariff-affected goods haven’t lowered their prices (exclusive of tariffs) to compete in the U.S. market. Further, the bank noted that non-Chinese producers of goods subject to duties appear to have raised their prices in response to being protected from competition from China. “These two findings suggest that both the direct effects and the indirect or spillover effects of the tariffs on U.S. inflation have been substantial,” the note said. “Indeed, consumer prices in tariff-affected categories have risen much more than other core goods prices in the CPI and PCE indexes.”

Tariffs and Consumer Spending: Because U.S. consumers are having to bear the extra costs of tariffs, it seems logical that this inflationary pressure might end up eating into consumer’s willingness to buy more-expensive goods. This might not bode well for the Consumer Discretionary sector. These companies are vulnerable to pullbacks in consumer spending because, unlike basic household products sold by Consumer Staples companies, people don’t have to have their products regardless of how the economy is doing.

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