Holiday Weekend Ahead After Another Course Of Retail Earnings, Geopolitics

Ah, a long holiday weekend. Barbecues, picnics, beach trips. But first, Wall Street has one more session to work through.

In what might seem like another episode in a season of re-runs, today offers geopolitics and retail earnings to usher in the three-day break. Earnings from two key retailers and more scuttlebutt around the North Korean situation made headlines early Friday, along with a drop in crude oil prices.

If the Shoe Fits…

Foot Locker, Inc. FL shares rose 15 percent in pre-market trading after the company easily beat Wall Street analysts’ expectations, posting EPS of $1.45 vs. expectations of $1.24 per share. Revenue of $2.03 billion also beat estimates. FL is a retailer that tends to draw traffic to its brick-and-mortar stores in this digital age and looks like it might be a nice turn-around story. For whatever reason people like to try on shoes before they buy them. Maybe because it’s really rough to have a shoe that doesn’t fit right.

On a different note, Gap Inc. GPS shares slid 8 percent in pre-market trading. Same-store sales climbed a little less than analysts had expected, and earnings per share came in below Wall Street’s consensus estimate. Old Navy has been a driver for GPS, but same-store sales there rose 3 percent, down from 8 percent a year earlier.

Geopolitics continues to play a big role, especially now that earnings season is on the wane. President Trump’s announcement early Thursday that talks with the North Korean leader were cancelled seemed to hit the market—especially the $DJI—pretty hard as it fell to its lows for the day shortly after the news.

What investors might fear more than lack of progress in talks with North Korea is the potential impact of the cancellation on U.S. trade relations with China. The U.S. and China have been working together to ease tensions on the Korean peninsula, and one school of thought is that investors might worry U.S./China trade talks could falter without the Korean issue to keep the two countries on the same page. That remains to be seen.

There appeared to be some optimism developing early Friday when North Korea said it’s still open to talks in the future. The country issued what sounded like a friendly statement with kind words for President Trump. European stocks rose overnight, but Asian stocks had a mixed feel.

On Thursday, Wall Street lit up mostly red amid new geopolitical concerns and falling oil prices. Seven of the 11 S&P 500 sectors fell, and the previously high-flying energy sector had the worst day with losses of more than 1.6 percent. Oil prices remain near three-year highs, but eased a little Thursday amid some talk in the financial media that OPEC might ease constraints on production. By Friday morning, the price of U.S. crude had fallen below $70 a barrel amid news reports that Russia could potentially raise output.

Even with Thursday’s losses, energy remains one of the best-performing sectors over the last month, and the S&P 500 Index (SPX) remains well above what many analysts see as a psychological support level of 2700. Both the SPX and the Dow Jones Industrial Average ($DJI) managed to claw back from sharp early losses. The Nasdaq (COMP) finished the day barely changed as the so-called “FAANG” stocks managed to finish close to even for the most part.

OPEC Back in the Conversation

The decline in crude oil prices Thursday might have weighed a bit on the stock market, because heavy demand for oil and rising crude values often signal economic strength. Crude is now down more than 2 percent from recent three-year highs and OPEC is meeting in about three weeks. Investors might want to keep an eye on that one to see if the decision makers there decide to free up the flow a bit to compensate for supply issues associated with Iran and Venezuela. At this point, OPEC is curbing production by about 1.8 million barrels a day, which, for comparison’s sake, amounts to about 17 percent of U.S. daily production.

One interesting thing to see Thursday was some buying in the rate-sensitive telecom and utilities sectors. These two had been under pressure the last month thanks in part to rising U.S. Treasury yields, but they might have gotten a break this week when the Fed came out with minutes that some investors interpreted as dovish-sounding. Speaking of that, the benchmark 10-year Treasury yield dropped to around 2.97 percent by the end of the day Thursday. That’s near two-week lows.

There was a negative signal from the housing market Thursday when the government reported that existing home sales fell 2.5 percent in April to an annualized rate of 5.46 million units, below Wall Street analysts’ expectations. The key takeaway remains the same: Supply constraints continue to act as a drag on overall sales, and affordability pressures from rising mortgage rates aren’t helping either, Briefing.com noted. This combination could hit prospective first-time buyers particularly hard.

One theme this entire earnings season, as we’ve been noting, is that beating estimates may not be enough. Best Buy (BBY) found that out Thursday, with its stock retreating more than 6 percent despite surpassing Wall Street’s consensus estimates on most measures with its results. However, the company’s margins didn’t line up with revenue and that seemed to be the rub for some investors.

Volatility has been muted most of the week, but jumped a bit early Friday as the Cboe VIX rose back above 13. On days like this ahead of a long weekend, volume can be thin. That might set up some choppiness.

Figure 1: Thanks for the Lift: As benchmark 10-year Treasury yields (candlestick) slid back below 3 percent this week, the utilities sector (purple line) began to climb. Utilities, along with telecom, are two of the more rate-sensitive sectors that now seem to be getting more interest as yields retreat a bit. 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.

Fed and the Long-Term

The Fed isn’t everything, but its statements often have a profound impact and even long-term investors should consider paying close attention. For instance, Fed minutes released this week got a dovish read from many analysts. They showed the Fed willing, it appears, to accept slightly higher inflation to allow more economic growth. If you’re a long-term investor and the Fed seems to be getting a little less hawkish, the mid-year portfolio check-up you’re hopefully considering gains additional importance. It means investors might want to check the percentage of their allocations in some of the more interest-rate sensitive sectors that had been slumping as the Fed raised rates, and also consider their balance between stocks and fixed income. Growth stocks, which would conceivably be hindered by higher rates, might not be facing that as much. The only caveat is that the Fed could come out next month and say something very different, depending on data between now and then.

Digging Deeper Into Fed Minutes

The Fed is arguably at a tipping point, caught between competing reasons for staying on its recent more hawkish path or becoming more dovish. Making the dovish argument, the bond market has flagged and the benchmark 10-year yield rose above 3 percent this month even as the benchmark German yield rests at 0.5 percent. That’s a very wide gap, and people tend to forget how interrelated the central banks are. When U.S. yields climb this much above yields elsewhere, it can start to have a negative impact on U.S. exports, and the Fed might not want that spread to get too far out of hand. That has to be balanced, however, with the fact that China is the biggest foreign buyer of U.S. debt. If the Fed relaxes on rates, the potential rise in U.S. Treasury bond prices accompanied by lower yields might make U.S. debt less attractive to the Chinese. So the Fed has a tough job ahead. The futures market has pretty much built in a rate hike for June, but after that, it’s a little more up in the air. The press conference and statement after the Fed’s June meeting could start to look pretty important.

Are We There Yet?

It’s hard to blame people for feeling like retail earnings go on and on, but the end of the road is in sight. Today’s earnings from Foot Locker (FL) mean we’re almost there, but that doesn’t mean investors can necessarily take their eyes off the road. For instance, Costco Wholesale Corporation COST and lululemon Athletica Inc. LULU are both scheduled to report next week, marking two more chances to get a sense of how consumers are doing. So far, they seem to be faring pretty well, if you look at the majority of retailers reporting this quarter and April retail sales. Consumer discretionary was one of the few sectors to post gains Thursday. One question, however, is if the rise in gas prices to $3 a gallon this spring might put a brake on consumer spending.

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