About Face: Stock Market Sentiment Reverses As Yield Curve Inverts, Data Disappoint

Well, that didn’t last long. Less than a day after the market got a shot in the arm on the tariff front, warning signs here and abroad seem to be flashing “recession.”

Sentiment has slipped back into negative territory after German GDP data showed Europe’s largest economy contracted by 0.1% during Q2. Also, official figures revealed Chinese industrial production slowed to the slowest rate since 2002 and retail sales growth there was below expectations. 

Meanwhile, a potential recession signal for the United States flashed red, as the yield on the 10-year Treasury slipped below that of the 2-year, a so-called inversion. Also, the yield on the 30-year treasury hit an all-time low as investors moved money into the relative safety of longer-term U.S. government debt. 

Investors have been watching the 2-year-10-year spread because it has preceded most recessions since WWII. However, it isn’t a perfect predictor, and much of the buying in the 10-year Treasury recently may be trade-based rather than solely from worry about the economy. And investors may also want to keep in mind that there tends to be a lag between an inversion and a recession, and during that time the market can actually gain ground. 

With yields on the back foot, today could end up being a rough day for the Financials sector, as it can be harder for banks to earn money when they can’t charge as much interest on longer-term loans compared to the shorter-term rates they pay out to depositors.

As the market appears poised for a reversal of yesterday’s trading in equities, Wall Street’s main fear gauge, the Cboe Volatility Index (VIX) is back above 20 and gold futures are higher. Meanwhile, the worries about the global economy appear to be weighing on oil prices.

In corporate news this morning, shares of Macy’s (M) were down more than 15% after reporting earnings per share that came well short of the Street’s expectations, in another sign that stores that rely more heavily on foot-traffic may be struggling with the rise of online shopping. Same-store sales growth was also lower than forecast. (See more on retailers below.) 

Stocks Found Relief After Some Tariffs Delayed

This morning’s reversal in sentiment comes a day after the stock market got some relief as the U.S. said it would delay the 10% tariff facing some goods from China from Sept. 1 to Dec. 15, meaning items like cell phones and laptops won’t face the duty during most of the holiday shopping season. Other items were removed from the tariff list altogether.

Investors seemed to take the news as a sign of a thaw in trade tensions between the world’s two largest economies. But President Trump said that he was delaying the tariffs out of concern for U.S. consumers during the Christmas season. So it’s possible that some of the underlying issues keeping the two sides from a deal could still be factors, and the trade war might not let up for some time.

Tech, Consumer Discretionary Sectors Benefit

Still, the market seemed to take the news favorably, with the Information Technology sector a standout performer, jumping nearly 2.5%. Chipmakers Micron Technology, Inc. MU and Lam Research Corporation LRCX, along with phone and laptop maker Apple Inc AAPL helped lead the sector higher as the companies have substantial exposure to the Chinese market.

The Consumer Discretionary sector was the second-best performer of the day, led by Best Buy Co Inc BBY and helped by Nike Inc NKE and Hasbro, Inc. HAS as the delayed tariff list included video game consoles and computer monitors as well as certain toys, footwear and clothing. 

After the initial surge on the news wiped out early losses, the trading day calmed, with the main three U.S. indices steadying at higher levels without giving up a lot of gains. That stability may have come as a relief to investors battered by high volatility last week and earlier this week. The market’s main fear gauge, the VIX fell nearly 17% to below 18. As appetite for riskier assets increased, investors sold U.S. government debt, pushing the yield on the benchmark 10-year Treasury above 1.7%. 

What Happens If Trade War Ends?

While the U.S.-China trade situation arguably remains the biggest overhang for investors, a resolution could end up being a bit of a double-edged sword. If that drag on global economic growth goes away, that would remove a big reason the Fed has had for cutting rates. And with the U.S. economy doing OK, it’s arguable the central bank could move to a less dovish stance.

Still, that might not create huge problems for equities if yields remain low, making dividend stocks more attractive. But, if bonds sell off because people are less worried about the global economy, that would push yields higher, offering more competition for yield bearing stocks. 

We may have been seeing some of that competition yesterday, as it seems investors were moving money that had been in bonds into higher-yielding dividend stocks. 

FIGURE 1: TECH RELIEF. The S&P Information Technology sector (IXT - candlestick) outperformed the wider benchmark S&P 500 Index (SPX - purple line) on Tuesday as chipmakers and AAPL got a boost on news that Washington will delay tariffs on cell phones and laptop computers. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Retail Reprieve: With news that certain consumer goods won’t face tariffs until December, retailers had a pretty good day on Tuesday, with TJX Companies Inc TJX, Ross Stores, Inc. ROST, and Kohl’s Corporation KSS all up around 3%. The delay until Dec. 15 means that for most of the holiday shopping season consumers won’t see a rise in price for certain footwear and clothing items they may want to buy. The U.S. consumer has shown strength even as Wall Street has fretted about the trade war. Now, with a reprieve, they may continue showing that strength into the holiday season, which is crucial for retailer performance. 

Still, it’s interesting that President Trump specifically said not impacting Christmas shoppers was the reason for the delay in implementing the tariffs, as it could be perceived as a concession to those worried that the tariff war will cause the costs of goods to rise for Americans. We’ll get the latest snapshot on how retail sales in the country have been doing when the government releases its report Thursday. July retail sales are expected to be up 0.3%, according to a Briefing.com consensus. 

Inflation Balancing Act: Although the Fed’s preferred inflation gauge is the core personal consumption expenditures price index, the market still closely follows another gauge of consumer spending—the core consumer price index put out each month by the Bureau of Labor Statistics. Both exclude prices for volatile food and energy prices and can give a decent snapshot of inflation trends. Data on Tuesday from July showed core CPI rising by 0.3% for the month, slightly ahead of expectations, and core CPI rising 2.2% year over year. That annual figure was higher than the 2.1% we saw in June and is a tick above the Fed’s target of 2%.

That seems to be putting central bankers in an interesting position. On the one hand, we’re seeing inflation growth in the United States, where gross domestic product and the jobs market seem relatively healthy. But on the other hand, possible threats to the global economy have helped shape the Fed’s dovish stance. “The key takeaway from the report is that it muddles the monetary policy outlook,” Briefing.com said. “The year-over-year readings are not exactly ‘rate-cutting’ material, but with everything else going on, the market will be left to conclude that another rate cut is likely since the Fed will want to ensure that everything else going on doesn’t lead to a caustic slide in inflation expectations.”

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