Brexit, China Fears Both Appear To Weigh On Market Early Despite Strong Best Buy Results

In case you forgot about Brexit, it hasn’t gone away and it’s still having an impact on the market.

Take this morning, for instance. A Cabinet member resignation over Brexit along with anticipated election results favoring EU-critical party members in the UK continue to weigh on stocks in that country, leading to a rough go for the British pound as well. 

This, along with fretting over Chinese tariff talks with no date set for further negotiations, weighed heavily on S&P 500 futures in the early going Thursday. Shares of Apple Inc AAPL have come under pressure this week amid concerns that the trade war could affect its products.

To make matters more bearish, we’re also seeing 10-year Treasury yields near 52-week lows this morning at just above 2.36%. To find a time when they were below these levels, you have to go back to December 2017. Typically, falling yields indicate investor worries about economic growth, though in this case they might be getting pulled down partly by negative yields in Europe and Japan.

It doesn’t look like the market is getting much early help from better than expected Best Buy Co Inc BBY earnings. The electronics retailer reported much better earnings per share than analysts had estimated, and met revenue expectations. Same store sales rose just a bit more than analysts had forecast, and the company confirmed its previous guidance. Shares rose more than 3% in pre-market trading.

Retail earnings aren’t over yet, with Ross Stores (ROST) due after the close today and Foot Locker, Inc. FL expected to report early tomorrow. The FL call might be particularly interesting for any insight into how tariffs might affect the company. Recall that earlier this week, FL was one of a number of shoe firms writing to President Trump and urging him to consider a halt in raising tariffs on footwear imported from China.

In other corporate news, the taxiway still looks crowded for Boeing Co BA after the acting head of the Federal Aviation Administration (FAA) told reporters yesterday that he couldn’t predict when the company’s 737 MAX  fleet would be back in the air.

Fed Seems Willing to Wait

There’s that word again: “Patient.”

It seems to be one of the Fed’s favorite terms this year, and it came up again in the May Fed minutes released Wednesday afternoon. Based on the minutes, it looks like rates might stay right where they are for a long time, even if economic conditions get better.

“Members observed that a patient approach to determining future adjustments to the target range for the federal funds rate would likely remain appropriate for some time … even if global economic and financial conditions continued to improve,” the minutes read.

That potentially could open the door to more economic growth without the overhang of a potential rate hike, which is a bullish scenario and might have spurred a move in the markets away from defensive sectors in the immediate aftermath of the minutes’ release.

On the other hand, the Fed’s patience might mean it’s not ready to make any quick rate cuts, either. One school of thought suggests that the Fed might be hesitant to quickly cut rates if there’s a soft spot in the economy because at current interest rate levels it just doesn’t have too many arrows in its quiver to address a major recession if one occurs. Keep in mind that the current Fed funds rate is well below historic averages, even if it seems relatively high compared to levels of basically zero between 2008 and 2015. 

Until this year, the Fed had signaled its intention to raise rates at least twice more in 2019, but those predictions went out the door after the economy’s Q4 weakness. So the Fed could be stuck at current levels for a while barring any major economic meltdowns. Futures market odds for a June rate cut fell below 4% after release of the minutes. However, CME Group futures still show nearly a 70% chance of a cut before the end of the year, which could reflect concerns over how the trade war might affect the economy.

Some Embrace Risk After Minutes, But Defensive Plays Still In Vogue

Though the stock market stepped back Wednesday from Tuesday’s gains, it’s interesting to see that there was a slight shift into risk assets right after the Fed minutes hit the tape. Treasuries came off their highs, and volatility, as measured by the VIX, backed off. For Wednesday as a whole, however, the so-called “defensive” parts of the market generally did best, with Utilities, Real Estate, and Health Care among the biggest gainers.

Energy shares fell to the bottom of the scoreboard Wednesday as crude oil slid in reaction to another large U.S. weekly stockpile build. Crude is now back to testing recent two-month lows, with the psychological $60 a barrel level not far below current prices.

Some of the market softness Wednesday might have reflected disappointing retail earnings over the last week. Watching major retailers cut guidance certainly didn’t seem to help Wall Street’s mood. It’s possible some investors might be getting nervous about tariffs and consumer sentiment, and whether those factors might affect retail margins. We’re starting to hear that retailers might pass along some of their higher transport and tariff costs to consumers. That potentially could drive inflation higher, something the Fed might eventually have to take into account. If inflation starts climbing and unemployment remains low, it might end up testing that famous Fed “patience.”

“Good” and “Bad” Inflation 

When you look at inflation, there’s two kinds. There’s “demand-pull,” which is the good kind of inflation because it reflects strong consumers and can be addressed by increased capacity and other business investments. There’s also the negative kind of inflation, which is “cost-push,” and that’s the type of inflation caused by tariffs. It could start to weigh on real wages and hurt consumer sentiment and willingness to spend. That’s arguably why it could be important to watch inflation readings closely in coming months if the tariff spat doesn’t get solved. The Fed’s favored inflation monitor, Personal Consumption Expenditures (PCE) prices, come out at the end of next week with inflation data for April.

While Treasury yields fall, the Dollar Index continues to stay relatively high. It finished Wednesday up above 98, not far from this year’s peak and up about 2% over the last two months. The strong dollar might be a headwind for multinational U.S. company earnings this quarter. We’ll have to wait and see.

The economic calendar looks a bit light as the weekend approaches, but April new home sales come out today and durable orders for April loom on Friday morning. Analysts are looking for about a 2% drop from a month earlier in durable orders, according to Briefing.com. However, with transportation orders factored out, analysts expect a slight increase month-over-month. Nondefense capital goods, excluding aircraft, jumped 1.3% in March, and are seen as a proxy for business spending. So it might be prudent to check that figure when it comes out Friday, because capital expenditures have generally been less than outstanding recently.

Figure 1: Figure 1: SEPARATE WAYS: Strength in the Dollar Index (candlestick) often is associated with strength in 10-year Treasury yields (purple line), but that hasn’t been the case recently. The dollar continues to look solid, perhaps because U.S. economic growth has been impressive, but borrowing costs are falling partly due to low rates overseas and amid fears of trade disruptions. Data Sources: ICE, Cboe. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

No Follow-Through Yet On China’s Treasury Threat: One element of the trade spat that’s faded a bit in recent days is worry about China threatening to reduce its investment in U.S. Treasuries. Earlier this month, reports about the chances of that happening raised some eyebrows, but it’s a questionable tactic. By selling Treasuries, China would reduce prices, hurting itself in the process.  An initial report that China might be looking to dump Treasuries could simply be part of the negotiations tactics as Beijing and Washington continue to jockey over trade. 

Another reason China might not take that dramatic step—which would probably cause upheaval in markets around the world and perhaps spike U.S. interest rates—is that there just isn’t another place where the Chinese government could get so much for their money. Even with the 10-year Treasury yield at under 2.4% as of Wednesday, that sure looks like a decent return compared with negative yields in Japan and Germany, and around 1% in the U.K. At this point, China holds about $1 trillion in U.S. government bonds, or about 5%of total outstanding U.S. debt.

Reading the Housing Tea Leaves: It’s never a good idea to make any huge assertions based on one particular month of data, but April’s existing home sales this week—accompanied by recent earnings from some of the home-building and supply companies—point to a couple of interesting possibilities. Mainly, that the more expensive new home market seems to be gaining some ground while cheaper existing homes aren’t quite there yet. Existing home sales for April fell short of analyst expectations, down more than 4% from a year ago. 

While April new home sales are out later this morning, luxury home builder Toll Brothers Inc TOL recently noted a lot of reasons for hope in new home demand, including gathering momentum this spring and bullish macroeconomic trends. On the other hand, some of the home supply companies like Home Depot Inc HD and Lowe’s Companies, Inc. LOW disappointed investors with their results, and that could speak to home owners who aren’t looking for a flashy new house perhaps not spending as much to improve their current kitchens and baths. That might square with what some CEOs said in earnings calls for Q1, noting that consumers seem to be spending a lot on smaller things, but not so much on big-ticket items. As anyone who’s ever renovated a home probably knows, that’s definitely a “big-ticket” expenditure.

Extra Day/Extra Volatility?: The coming weekend is a long one in the U.S., so that could mean some volatile trading today and Friday as many traders attempt to position themselves for the extra day off. In this environment, with the tariff battle getting played out publicly and sometimes hour-by-hour, it’s questionable how many people will want to risk carrying large positions through the weekend. That means we could see what’s called “position-squaring” in the closing hours Friday, making for a crowded trading environment. It’s also possible that some of the so-called “defensive” parts of the market, including sectors like Consumer Staples and Utilities, as well as gold, the dollar, and U.S. Treasuries, might attract more of a bid in the next day or two. Treasuries already were on the rise Wednesday, with the 10-year yield falling back below 2.4%. The message to long-term investors is to consider not watching every market move over the next two days and sticking with your strategy. Caution is never a bad thing, and trades made in the heat of emotion as the market quickly rises or falls often aren’t the most carefully considered.

Information from TDA is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade.

Image sourced from Pixabay