Pressure Packed: Overseas Weakness Continues To Weigh As Data- and Earnings-Heavy Week Begins

(Monday market open) Stocks began Monday licking their wounds after the worst week in more than a month. The tech-heavy Nasdaq 100 (NDX) suffered its first losing week since April. Hawkish talk from the Federal Reserve and other central banks, accompanied by worries about the global economy, ganged up on U.S. and other major markets over the last few sessions.

Softer reads on manufacturing proved the dagger Friday as Wall Street wrapped up a week where every S&P 500 sector besides health care sank. Real estate, energy, and utilities formed the back of the pack. Still, the S&P 500® Index (SPX) is down just 2% from the 14-month high recorded June 16 and remains above a key technical support level of 4,325.

It’s possible things just got stretched too far earlier this month and the market is reverting toward a mean. The broad pullback was accompanied by three-year lows in volatility, a reassuring trend. The question is whether “buy the dip” shows up if that 4,325 level is breached—something we may learn soon.

Stocks have a weaker tone heading into Monday’s session after softness overnight in Asian and some European markets. The situation that played out in Russia over the weekend doesn’t appear to be having a major impact on the markets, but if things heat up again there, it could potentially lift crude oil, Russia’s major export.

Morning rush

• The 10-year Treasury note yield (TNX) dropped 4 basis points to 3.69%.
• The U.S. Dollar Index ($DXY) is flat at 102.72.
• The Cboe Volatility Index® (VIX) futures jumped to 14.29 but remains near recent 3-year lows. Contracts for later this year are higher, however, signaling that investors expect more volatility down the road.
• WTI Crude Oil (/CL) rose slightly to $69.63 per barrel after the weekend’s attempted rebellion in Russia.

It’s not breaking news that the Treasury yield curve remains inverted, meaning short-term notes carry higher yields than longer-term ones. That’s been true for many months. What’s new is that the curve is back to 100 basis points after narrowing from more than 100 to around 50 earlier this year.

Ten-year bond yields have been moving sideways lately—caught between signs of slowing growth and the threat of more Fed rate hikes due to “sticky” inflation, observes Kathy Jones, Schwab’s chief fixed income strategist. Meanwhile, short-term rates keep edging higher. As of Friday, the 2-year Treasury note yield traded at 4.77% and the 10-year Treasury note yield stood at 3.74%. (See more below on what this might mean).

Eye on the Fed

Futures trading points to a 72% probability that the Federal Open Market Committee (FOMC) will raise rates 25 basis points at its July meeting, according to the CME FedWatch Tool. On Wednesday morning U.S. time, Fed Chairman Jerome Powell is scheduled to participate in a European Central Bank (ECB) policy panel discussion in Portugal.

It’s arguable that we’re seeing the market’s focus change from inflation risk to economic risk. The softness last week resulted from disappointing manufacturing data from around the globe, not from screaming hot inflation numbers. One thing to note: Recent days of weakness in the stock market accompanied weakness in Treasury yields. However, any rally in Treasuries faces possible resistance from a large influx of new government bonds.

What to Watch

Today’s a light data day, but the Treasury Department has a few auctions scheduled that may be worth watching to assess demand for fixed income, especially as short-term rates have risen over the last week. More auctions take place in coming days.

• Tuesday morning brew: Soon after the opening bell tomorrow come the May New Home Sales and June Consumer Confidence reports. The homes tally could be solid considering the strength seen in last week’s Housing Starts and Building Permits figures. New home sales have been trending upward this year after last year’s steep drop.
• New home sales are seen at a seasonally adjusted 670,000 in May, down from 683,000 in April, according to Trading Economics. New home sales have climbed steadily since their lows last fall, and some homebuilders hint that buyers are growing used to elevated mortgage rates.
• Consumer Confidence from the Conference Board is expected to come in at 103.5 in June, up from 102.3 in May, Trading Economics says.
• Window washing: Because this is the final week of Q2, we may see what Wall Street veterans colloquially call “window dressing.” That’s when major fund managers exit losing positions and buy stocks with better track records to present cleaner reports to clients. It could mean more volatility in coming days.
• Weekly diary: The calendar ahead includes the government’s final estimate for Q1 Gross Domestic Product (GDP) growth on Thursday. The most crucial report before the end of the quarter is this Friday’s May reading on Personal Consumption Expenditure (PCE) prices, the inflation metric most closely followed by the Fed. The last PCE update—for April—showed an annual increase of 4.4% in the overall rate and 4.7% in the core rate, which excludes food and energy prices.

Stocks in the Spotlight

Earnings alert: Three major firms share quarterly results this week, a reminder that earnings season approaches.

It starts tomorrow before the open with Walgreens Boots Alliance WBA. Shares of the pharmacy chain rose the last time it reported in late March, as earnings beat expectations. However, spring didn’t provide much sunshine for shareholders, who watched the stock sink along with shares of competitor CVS CVS. One source of pressure could be the “lapping” of peak COVID-19 demand that helped drive profits a year ago.

Back in March, Walgreens said it expected strong growth in the second half of the year. One question that may arise tomorrow is the future of Boots, the company’s U.K.-based retail chain. Investors also will probably want to hear about cost-cutting to see if margin pressures ease.

Semiconductor giant Micron MU steps into the batter’s box Wednesday afternoon, offering investors a chance for the latest update on the memory chip market. The company’s previous quarter was tough from a supply chain perspective, so we’ll see if the situation improved.

Another “extra-wide” company reporting this week is Nike NKE, with results expected Thursday afternoon. Disappointing earnings and guidance from Foot Locker FL in late May cast shadows ahead of Nike’s report. As a reminder, Nike and Foot Locker have a partnership, and Foot Locker said it was dealing with a “constrained supply” of Nike products.

Brace for banks: Consider watching financial stocks on Wednesday when the Fed shares results of its latest round of “stress tests” on the nation’s largest banks. These annual tests help determine whether banks have the necessary capital cushion in case of a major shock to the system. Results often help determine whether the big Wall Street banks can raise dividends and buy back shares.

Thinking cap

Ideas to mull as you trade or invest

Vulnerabilities surface: Recent weakness in the Russell 2000 (RUT) index of small-cap stocks might reflect rising Treasury yields and worries about the economy. Small companies are often more dependent than larger ones on borrowed money, and the benchmark 10-year Treasury note yield is up more than 40 basis points from recent lows. Meanwhile, last week’s news that May Leading Economic Indicators (LEI) fell for the 14th consecutive month is a reminder that smaller companies tend to be more sensitive to U.S. recession risk than larger companies with greater overseas sales exposure.

Inversion reversion: The 2-year Treasury note yield remains below last year’s peaks of above 5%, but its rally versus the 10-year yield is far from bullish for stocks. It could signal growing belief that interest rates are likely to rise and remain elevated for some time. The narrowing of the curve between the 2-year and 10-year yields a couple months ago might have reflected ideas that the Fed would hold off on future rate hikes after several bank failures. That doesn’t seem to be happening. An inverted yield curve often indicates economic softness ahead. If you believe what the yield curve says, the double-whammy of higher inflation and rising interest rates (which tend to slow economic growth) paint a potentially disappointing picture. Stagflation is the “he who must not be named” of the stock market.

Being green: Despite a rally Friday, the U.S. dollar index continues trading in a narrow range between roughly 100 and 105, where it’s been most of the last six months. The stability of this crucial asset arguably helped set the stage for what’s been a less volatile 2023 stock market, despite all sorts of volatility in bonds. In contrast, the dollar was all over the map last year, ranging from below 95 to above 114. The dollar index hasn’t been this rangebound since 2019. A move out of the range, if it happens, might be seen as bearish for stocks, whether it’s down or up. If the dollar climbs above 105, it could be a sign that investors expect an even more hawkish Fed. A drop below 100 could reflect heightened worries about the U.S. economy, though it would probably be helpful for U.S. companies in sectors like info tech and industrials that have a large percentage of overseas sales. However, last week’s disappointing manufacturing data from Europe lifted the greenback versus the euro, making any forecast for a near-term dollar dip below 100 look premature.

Calendar

June 27: June Consumer Confidence, May New Home Sales, May Durable Orders, and expected earnings from Walgreen’s Boots Alliance (WBA)

June 28: Expected earnings from Micron (MU) and General Mills (GIS)

June 29: Q1 Gross Domestic Product (third estimate), May Pending Home Sales, and expected earnings from Nike (NKE), McCormick (MKC), and Rite Aid (RAD)

June 30: May Personal Consumption Expenditures (PCE) prices, May Personal Income and Personal Spending, and Final June University of Michigan Consumer Sentiment

July 3: June Chicago PMI, June ISM Manufacturing Index, and May Construction Spending

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

 

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