A Big Earnings Miss By Target May Take Yesterday’s Rally Off Course - Advance Auto Parts (NYSE:AAP), Applied Mat (NASDAQ:AMAT)

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(Wednesday Market Open) Equity index futures were pointing to a lower open after Target TGT reported earnings with issues similar to Walmart WMT results on Tuesday. A few more big retailers released mixed earnings reports.

Potential Market Movers

Target (TGT) plunged 22.5% in premarket trading after a big miss on earnings estimates and executives offering much lower guidance, including revenue growth falling into the single digits. The company attributed its earnings miss to unexpectedly high costs, supply chain problems, and rising transportation expenses.

However, TJX Companies TJX, owner of discount stores like T.J. Maxx, Marshalls, and HomeGoods, reported better-than-expected earnings despite lower-than-expected revenues. The company also reduced its forward guidance as demand for apparel and home goods is slowing. TJX is forecasting U.S. same-store sales growth at 1% to 2%. The stock fell 2% in premarket trading but rallied to more than 2% on the positive side before the opening bell.

Lowe’s LOW also reported mixed results, beating on earnings but missing on revenues and reaffirming their forward earnings guidance. Lowe’s rival Home Depot HD increased their outlook on Tuesday, which makes Lowe’s guidance look worse. Lowe’s saw total sales drop by 4% in the first quarter which was also lower than analysts’ expectations and even weaker compared to HD’s record first quarter.

In other corporate news, Netflix NFLX is laying off 150 employees companywide, reducing staff by 2%. The layoffs come a month after the streamer reported its first subscriber loss in a decade with a forecast of future subscriber losses. Netflix now joins other companies, particularly in tech, that are beginning to lay off workers or announce hiring freezes.

Minneapolis Fed President Neel Kashkari told a Michigan Chamber of Commerce audience that it’s not clear if the U.S. is heading into recession but said that supply chain improvements could limit the number of rate hikes. Mr. Kashkari was unsure how many rate hikes will be needed to slow inflation to the Fed’s 2% goal.

The Fed’s rate strategy is softening the housing market as building permits fell 3.2% in April and housing starts fell 0.2%. Additionally, mortgage applications fell 11% in the last week. The news could be a drag on homebuilder Toll Brothers TOL which announces earnings next week and traded 1.78% lower premarket.

Rising inflation is also being felt at the pump as gas prices are reaching record highs. In fact, many politicians are looking to create a gas tax holiday. However, making gas cheaper by reducing taxes at the pump could prompt increased buying which would likely strain already-reduced gas supplies.

The Cboe Market Volatility Index (VIX) was slightly higher this morning, trading above 26. If the VIX can hold these lower levels, then the market has greater likelihood of building a base in which the bulls could mount a run.

Reviewing the Market Minutes

Stocks rallied out of the gate Tuesday as the U.S. Dollar Index ($DXY) continued to retrace its previous price gains. The dollar has fallen three days in a row which provided some relief to multinational companies facing currency headwinds. Several companies like Amazon (NASDAQ: AMZN) specifically warned investors during their conference calls that the strong dollar will likely hurt earnings.

The S&P 500 (SPX), which is made up of large- and mega-cap multinational companies, rose more than 2% on the news. However, the rally was interrupted by comments from Federal Reserve Chair Jerome Powell reiterating the Fed’s commitment to combatting inflation. The SPX bounced back to close 2.02% higher.

This is a reminder that the specter of rising interest rates continues to loom over the markets. While stocks appeared to be unaffected by the 10-year Treasury yield (TNX) rising 91 basis points during Tuesday’s session, higher rates are still a risk. Also, higher rates are a big factor behind the strength of the dollar that has haunted multinationals.

The other major indexes also closed higher with the Dow Jones Industrial Average ($DJI) rising 1.34% and the Nasdaq Composite ($COMP) gaining the most at 2.76%. Not to be outdone, the Russell 2000 (RUT) rallied 3.19% and S&P 500 Pure Growth Index edged out the S&P 500 Pure Value Index, returning 2.81% and 2.29% respectively.

Technology led all of the sectors with the news that Shanghai has reported no new COVID-19 cases in three straight days outside of quarantined zones. Many technology companies manufacture their products in China and particularly around Shanghai.

Asia is also seeing changes in pandemic restrictions with Hong Kong planning to relax its measures while Japan is opening up to small groups of tourists.

Homebuilders had a good day despite the NAHB Housing Market Index falling more than expected in May. The index was forecast at 75 but came in at 69, a large decline from April’s 77. The S&P Homebuilders Select Industry Index rose 2.72%.

CHART OF THE DAY: COMMUNICATION BREAKDOWN. The Communications Select Sector Index ($IXC—candlesticks) has fallen more than 30% from its high in September, causing it to underperform the S&P 500 (SPX—pink). The communications index has yet to demonstrate relative strength (green) against the S&P 500. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Failure to Communicate: Paramount Global PARA and Citigroup C respectively rose 15.35% and 7.56% Tuesday on the news that Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A) was building positions in both companies. However, Berkshire sold holdings in Verizon VZ. Like other communication companies, Verizon has struggled over the last year and has fallen 21% from its December 2020 high.

FactSet reports that the communications sector has a forward price-to-earnings ratio of 15.2, which is below its 10-year average of 16 and making it the fourth-lowest among sectors. Investors may see this as a sign that the valuations for communications companies are more attractive, but according to Refinitiv, the communications sector has had the lowest percentage of positive earnings revisions of all sectors during Q1.

Weak earnings and a lack of relative strength are negative signs for the sector.

Varying Views: According to an SEC filing, Michael Burry’s hedge fund is shorting Apple (NASDAQ: AAPL). Burry came to fame after successfully shorting the housing market in 2007 and 2008 which was fictionally chronicled in the film “The Big Short.” In recent years, Burry has expressed concern over index investing and the large flow of money into these funds building a potential bubble. Apple is a big part of many of these indexes, so it makes sense that he’s shorting the company.

Additionally, Burry sees inflation as a problem for Apple as well as many other technology companies, including Tesla TSLA. He expects inflation to cut the profit margins of these companies and reduce their profitability. In April, Burry tweeted that he believes “The Fed has no intention of fighting inflation” and that “The Fed’s all about reloading the monetary bazooka so it can ride to the rescue & finance the fiscal put.”

Alternatively, a few weeks ago, Warren Buffett told Berkshire investors at their annual meeting that the company has purchased more shares of Apple and plans to keep doing so at the right price. It’s not uncommon to see two or more well-known investors taking opposing positions. Their views can vary depending on the timeframe they’re focused on, the value of a company, a changing macroeconomic picture, or many other factors.

Store Brands: Consumers are tightening their budgets, and many are turning to private label or private brand products to save money. Private label products are manufactured and sold under a store’s brand name like Walmart’s WMT Great Value or Kroger’s KR Simple Truth. According to the Private Label Manufacturers Association, April dollar sales in store brands grew 6.5% compared to a 5.2% in national brands. In March, private label sales grew 8.3%, dwarfing national brand growth of 4.5%.

The dollar sale growth is a good sign for private label companies, but consumers are actually buying fewer units. With inflation, private label products can charge more while seeing smaller declines in unit sales than their national brand competitors.