Friday Retreat: After Wild Thursday Rally, Market Stumbles into Weekend as Inflation Fears Grow

(Friday Market Close) More hints of rising inflation and worries about U.K. financial markets blew out the lights on Wall Street’s one-day party today. The benchmark S&P 500® (SPX) retreated toward two-year lows and logged its seventh losing session in the last eight. 

After a solid start, the SPX quickly ran for cover amid rising Treasury yields. The market’s “third rail” appears to be a 10-year Treasury note (TNX) yield of 4% or higher. The yield reached that level today after flirting with it the last few sessions.

Friday’s losses capped a week that saw bank earnings come in mixed at best, accompanied by bearish inflation data. Be on the lookout next week for housing data, especially September Building Permits, a key leading indicator for the housing market.

Inflation Fears, U.K. Turmoil Drive Up Yields

Treasury yields rose today in part on higher consumer inflation expectations in the preliminary October University of Michigan Sentiment report.

One-year inflation expectations rose to 5.1% from the previous 4.7%, and five-year expectations increased from 2.7% to 2.9%. Despite that, sentiment rose slightly from September. The sentiment rise is another “good news is bad news” indicator, because the Federal Reserve is trying to clamp down on consumer spending to fight inflation.

The disappointing sentiment data followed bearish September Producer Price Index (PPI) and Consumer Price Index (CPI) reports earlier this week. The Federal Open Market Committee (FOMC) meets November 1-2, and the market prices in a 96% chance of a fourth-consecutive 75-basis point rate hike, according to the CME FedWatch Tool.

The FedWatch Tool also now pegs the chance of consecutive November and December 75-basis point rate hikes at nearly 70%. That means the Fed’s benchmark rate would finish the year between 4.5% and 4.75%, compared to 3% to 3.25% now.

Higher rates make it harder for companies to borrow, potentially slowing economic activity and raising the risk of recession. Commodity and metals futures prices fell broadly Friday as traders appeared to price in more recession fears. WTI Crude Oil (/CL) fell nearly 4%, and Copper—a metal used in many industrial applications—fell 1%.

Pressure also flew in from across the pond this morning as a result of more financial turmoil in the United Kingdom. The Bank of England (BOE) ended its price support program today for the bond market, helping send the U.K. 10-year “gilt,” or bond, yield up 17 basis points to 4.37%. It had fallen toward 4% Thursday.

Review Session: Friday’s Bank Earnings

Before today’s bell, JP Morgan Chase JPM, Morgan Stanley MS, Wells Fargo WFC, and Citigroup C all reported results. They were generally on the light side, but much of the bad news was priced into those stocks. Most of the big banks shares rose after their earnings reports.

JPM beat Wall Street’s earnings and revenue estimates, with revenue up 10% and bolstered by gains in net interest income amid rising interest rates.

However, that profit was down 17% from a year ago as investment banking took a hit, underlining the tough environment investment banking faces now with initial public offerings (IPOs) few and far between. JPM also set aside another $800 million to protect against possible loan losses (a year ago it had been reducing those reserves).

JPM’s stocks trading revenue fell year over year, but fixed income trading rose. It was also good to see JPM’s consumer and loan businesses trend positively during the quarter, and shares rose more than 5% ahead of today’s opening bell.

Outcomes were worse than expected with rival bank MS, which missed analysts’ quarterly estimates for both earnings and revenue after a tough quarter for investment banking. Revenue fell 55% in that MS division.

WFC, on the other hand, also enjoyed a net-interest income boost but took a $2 billion charge related to its long-running legal and regulatory issues. Shares still rose 2%. WFC missed analysts’ earnings estimates but outperformed on the top line. Earnings were down 31% from a year ago, another sign of the tough current environment.

It’s also a tough environment for C, which did beat analysts’ estimates on revenue and earnings per share. However, its loans were down from a year ago and overall profit fell 25%. Like other banks, C set aside more funds for potential loan losses.

Next Week’s Outlook

Bank earnings continue Monday with Bank of America BAC expected to report. Like JPM, BAC is closely tied to the consumer economy, so its quarterly results and outlook could provide more details about how consumers are dealing with high inflation and interest rates.

Next week is packed with earnings. Some major firms expected to report include AT&T T, American Airlines AAL, Lockheed Martin LMT, Netflix (NASDAQ: NFLX), Philip Morris PM, Union Pacific UNP, Abbott Labs ABT, Procter & Gamble PG, United Airlines UAL, Verizon VZ, and American Express AXP.

About 7% of S&P 500 companies have reported Q3 earnings results so far. Of those, 69% have reported  positive earnings per share surprises and 67% have reported positive revenue surprises, according to market research firm FactSet. However, FactSet now projects Q3 earnings growth of just 1.6%, down from 2.8% at the end of September. This would be the weakest quarterly earnings growth in two years.

Reviewing the Market Minutes

Thursday’s huge comeback might have been based in part on falling U.K. bond yields. On Friday, U.K. bond yields ticked back up, and the U.S. stock market came under pressure. Correlation isn’t causation of course, but there you have it. If you don’t usually follow the U.K. bond (or “gilt”) market, it might be a good idea to start doing that now.

The SPX fell about 86 points, or 2.37%, to finish at 3,583.07. the Dow Jones Industrial Average® ($DJI) backtracked 403.89 to 29,634.83. The SPX fell about 1.4% this week and finished only a few points above Wednesday’s two-year low close. But the $DJI actually rose slightly for the week.

The Nasdaq-100® (NDX) fell Friday and posted weekly losses, while the Russell 2000® (RUT) also had a week in the red.

Stocks started higher today, then dived. There was some stabilization early in the afternoon with the SPX battling for a while to hold 3,600, but the last hour of the day proved to be the “witching hour” once again. All the SPX sectors fell, and consumer discretionary and energy shares took the worst of it. Health care, financials, and utilities did best, but all were in the red.

Among individual stocks, Beyond Meat BYND got pounded. Shares fell 9% Friday after BYND said it’s cutting 19% of its workforce. The company is struggling with falling sales and inflation. Electric car companies Tesla TSLA and Lucid LCID also fell sharply. Higher inflation expectations tend to hurt consumer-oriented stocks.

Despite stock market losses, the Cboe Volatility Index® (VIX) didn’t show much muscle Friday, continuing its rangebound ways. It’s mostly been between 30 and 33 over the last week, and hung out near 32 today. The VIX might have to move toward the mid-30’s or above for stocks to fall out of bed much further.

CHART OF THE DAY:  Remember the VIX. Looking back to Thursday’s wild market turnaround from weak to strong, this intraday chart demonstrates how the failure of the Cboe Volatility Index’s (VIX—purple line) to rise despite market losses might have contributed to the midday recovery in the SPX (SPX—candlestick). The lesson? When in doubt, check the VIX. If it doesn’t agree with the major stock indexes, perhaps it’s telling you something. Data Source: S&P Dow Jones Indices, Cboe. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Taxman Visits: After many years of tiny inflation adjustments, around 70 million seniors will get an 8.7% bump in their Social Security and Supplemental Security Income (SSI) checks next year, as we mentioned earlier today. However, for wage earners, the news wasn’t quite as thrilling, because more of their pay will be subject to Social Security taxes in 2023. Based on an increase in average wages, the maximum amount of earnings subject to Social Security taxes will rise from $147,000 this year to $160,200 next year, the government agency said. Probably not enough to affect anyone’s pocketbooks much, but it’s still a slight tax increase for some folks. For investors, the Social Security bump—the highest in 40 years—and its associated rise in taxes are more evidence of how high inflation affects the economy.

Notable Calendar Items

Oct. 17: October Empire State Manufacturing and earnings from Bank of America (BAC)

Oct. 18: September Industrial Production, September Capacity Utilization, and earnings from Goldman Sachs (GS), Johnson & Johnson (JNJ), Lockheed Martin (LMT), United Airlines (UAL), and Netflix (NFLX)

Oct. 19: September Housing Starts and Building Permits and earnings from Abbott Labs (ABT), Procter & Gamble (PG), Biogen (BIIB), Travelers (TRV), Tesla (TSLA), and Las Vegas Sands (LVS)

Oct. 20: September Existing Home Sales, Philadelphia Fed Index, and earnings from Alaska Air (ALK), American Airlines (AAL), AT&T (T), Dow (DOW), Whirlpool (WHR), and CSX (CSX)

Oct. 21: Earnings from American Express (AXP), Schlumberger (SLB), Nokia (NOK), Blackstone (BK), and Verizon (VZ)

Oct. 24: Earnings from Royal Philips (PHG) and Northwest Bancshares (NWBI)

Oct. 25: October Consumer Confidence, and earnings from Archer-Daniels (ADM), Biogen (BIIB), General Electric (GE), General Motors (GM), Microsoft (MSFT), Alphabet (GOOGL), Texas Instruments (TXN), and Visa (V)

Oct. 26: September New Home Sales and earnings from Boeing (BA), Boston Scientific (BSX), Kraft Heinz (KHC), and Waste Management (WM)

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