Soft Touch: Home Depot's Earnings Miss, Caterpillar Downgrade Both Appear To Weigh

The week began with tons of positive momentum, but that appears to be dissipating a bit Tuesday morning. Asian and European stocks are lower and crude is struggling a little after a major plunge yesterday. Meanwhile, geopolitical news continues to swirl, but without any major new developments on the China trade front, investors might find themselves grasping for catalysts.

The day began with some disappointing news from Home Depot Inc HD, which missed analysts’ estimates on earnings and sales. Guidance also came in below the Street’s expectations, and shares fell about 2% in pre-market trading. 

The housing market, which HD and Lowe’s Companies, Inc. LOW are sometimes seen as barometers for, has been soft for a while due in part to rising mortgage rates. One school of thought suggested that companies like HD might be able to weather weak home sales because more people might decide to renovate instead and head to HD to buy building materials or new appliances. One earnings report isn’t a trend, but HD’s Q4 could raise some concerns and have people wondering if that thesis still works. LOW’s earnings are due tomorrow morning, so that might offer investors a better sense of whether HD’s Q4 miss was isolated or reflects any industry-wide issues.

In another negative development early Tuesday, shares of industrial giant Caterpillar Inc CAT crumbled nearly 4% in pre-market trading after an analyst downgraded the company because of what it said could be slowing construction sales next year driven by falling demand around the world. Industrials have led the way for the broader market so far this year, so any sign of cracks in the foundation might have an outsized impact on investor sentiment. The downgrade also might play into fears of slowing world economies, which is a separate issue from the potential trade deal with China and might persist even if an agreement gets signed.

Not all the corporate news was bad early Tuesday. Macy’s Inc. M shares got a bit of a lift after the department store beat analysts’ sales and earnings estimates. This came after the company told investors last month about its holiday season struggles. Same-store sales in the quarter rose a little more slowly than Wall Street had expected, but investors might be enthused about the company announcing a new restructuring plan Tuesday that it said in a press release could cut costs $100 million annually.

VIX Pops Up After A Long Slide

Stocks pulled back Monday to finish well off their highs, and one interesting development was a big jump in volatility as measured by VIX. That’s a U-turn from the recent trend and might be worth a closer look. 

Fear has steadily ebbed over the last few weeks, but it looks like at least on Monday we saw what could be a giant hedge take shape as tariffs got kicked down the road. There was a large amount of volume in the VIX calls, with the April monthly 20, 23, 26, and 30 strikes all trading more than 100,000 contracts on the day. The cash VIX price rose nearly 10% to finish Monday just below 15 after dropping under 14 on Friday. (Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time).

What can the average investor take away from this? It could just mean a few investors decided that VIX cash prices had become too low on an intraday basis and put hedges in place just in case there’s a bump in the road with Chinese trade talks later in the spring. If you look back a year to last February, many investors took a beating when they got caught in short VIX positions and the market turned on them. What we’re seeing now could be a little muscle memory at work.

Slow Mo?

Also, think back to last week, when the defensive Utilities sector started to see some strength and gold and the dollar stayed near recent highs. Though the geopolitical news has been good lately, there does seem to be a little caution in the market, and some of the momentum seen over the last nine weeks might be slowing down.

The S&P 500 (SPX) is up more than 11% year-to-date, but the U.S. 10-year Treasury note yield is actually down a tick since the start of the year. Some veteran market watchers might see that as kind of odd, and it could partly reflect the Fed’s newfound dovishness. However, it could also be a sign of investors flocking to so-called “safe haven” trades (though no investment can truly be considered safe). Remember, European economies continue to struggle and bond yields in Germany are near zero, which could make U.S. Treasury bonds look attractive by comparison. While the stock market’s continued rally apparently reflects hopes for a trade deal, the strength in bonds might reflect fears of economic sluggishness. The question is whether this pattern of both higher stocks and Treasuries can continue. 

One arguably positive sign is that both the Dow Jones Transportation Average ($DJT) and the Russell 2000 Index (RUT) of small-cap stocks both continue to outpace the broader indices. Historically, strength in these two indices has sometimes been a sign of underlying stock market health and pointed toward more gains. However, past isn’t necessarily prologue. Meanwhile, the SPX’s forward price-to-earnings ratio of 16.2 is back to just under the five-year average, according to FactSet, after falling well under it at the end of last year. So anyone looking at stocks now would probably have to search a little harder to find potential “bargains.”

Hungry For New Catalysts?

If stock market momentum is slowing, it might go back to the appetite for new catalysts. The news on Monday around China sounded pretty similar to what we heard last week. Tariffs are going to be delayed, and that’s hard not to see as positive, but people might be getting tired of hearing the same thing and want more information.

It’s also possible some investors might be getting worried about a “buy the rumor, sell the fact” trade setting up in the Industrial sector, which entered the week up 18% year-to-date amid optimism about trade talks. Industrials did continue to rise on Monday, however, and it was the more “defensive” sectors that ended up in the red.

Speaking of sectors, it was encouraging to see financials and info tech as two of the top three sectors on the leaderboard Monday. History shows that strength in those two sectors can often be associated with market rallies, so it could be interesting to see if they continue to perform well. One source of info tech strength Monday came from the semiconductors, a sub-sector that some analysts think could possibly benefit from a trade deal. Apple Inc AAPL also had a decent day.

When it comes to a trade deal, it’s important not to put the cart before the horse. Despite the recent progress, nothing is guaranteed, as President Trump himself said this week. Extension of the deadline appears to show, however, that U.S. and Chinese negotiators are working toward the goal of reaching a settlement that hopefully could help both economies grow. Markets are taking that as a very positive sign that fears of a slowdown due to tariffs could hopefully be mitigated.

Words From Washington

Focus might turn squarely toward the capital city today and tomorrow as Fed Chair Jerome Powell testifies to Congress. This is his chance to tell elected officials about the current state of the economy, and for them to ask him some questions. Powell’s been a Fed chair who tends to move the markets when he speaks, often negatively, so that might explain some of the uptick in volatility as well.

The Fed has already publicly said it’s committed to pause here and watch the data come in, but many analysts and the Fed itself (judging from its December “dot plot”) still don’t rule out possible rate increases this year. Powell is likely to get asked about that, and about the Fed’s balance sheet plan. It seems unlikely that Powell would say much that people didn’t already see in last week’s Fed minutes, but you never know, so it could be important to stay tuned.

On the data front, Q4 gross domestic product (GDP) Thursday is probably the key number to watch, along with today’s housing starts and consumer confidence. Another number to keep in mind comes Wednesday in the form of December factory orders. If the economy is truly slowing, this report could provide more evidence. Weakness in November business investment could potentially have translated into more softness in December, especially considering the weak stock market and government shutdown taking place then might have dragged on business confidence, Briefing.com said. However, the Briefing.com consensus is for a 1% month-over-month rise in the December headline number.

From a technical perspective, Monday’s action in the SPX had to look a bit disappointing. The index climbed above 2800 for the first time in months intraday but couldn’t hold that level into the close and finished just below it. This kind of move could seem kind of bearish if you put much emphasis on support and resistance levels, and failure to pierce 2800 could potentially increase fears that the rally might be losing steam.

Figure 1: VIX Ticks Up a Notch: It may not look like much on this three-month chart, but the VIX (candlestick) popped about 10% Monday in what appeared to be a possible sign of some investors starting to hedge volatility after long quiet period. The 200-day moving average for cash VIX is the blue line, and VIX recently fell below that level and has stayed there for several weeks. If that moving average gets challenged, it might be interesting to see if more buyers come in. Data Source: Cboe Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Nothing Too Taxing: As tax day approaches, it’s tempting to think most of the big changes might be behind us for now thanks to passage of the new tax law in late 2017. That doesn’t mean, however, there won’t potentially be some tinkering around the edges this year and maybe in years to come. One idea touted by some think tanks that might affect investors (if it ever becomes law) would allow taxpayers to reduce capital gains taxes by adjusting the initial value of an asset—like a home or a share of a stock— for inflation when it sells, The New York Times said. The thought behind this would be to free more money for investment, and some supporters of it have been meeting with the Trump administration, the newspaper noted. How much traction this idea ends up getting remains to be seen.  Other tax ideas being discussed include possibly extending some expired tax credits retroactively, such as deductions for private mortgage insurance and higher-education expenses.

FAANGs Step Up to Plate: With baseball’s spring training well underway, it may be worth noting that the FAANGs hit a rare grand slam Friday as all five companies in this group ticked higher.  It would have been back-to-back on Monday except for losses in Alphabet Inc GOOG. However, MarketWatch pointed out last week that FAANGs aren’t totally out of their slump. Four of the five remain below their respective 200-day moving averages. The only exception is Netflix (NFLX). Also, most of the FAANGs are getting outpaced by the S&P 500 (SPX) so far this year. 

While it’s possible to put too much emphasis on technical indicators like the 200-day moving average, they sometimes can help investors get a sense of bullish sentiment. It’s arguably bullish if a stock finds buyers after punching through a key technical point like the 200-day. The FAANGs were where a lot of the bullish momentum was last year, but they haven’t really led so far in 2019. In addition, famous investor and Berkshire Hathaway (NYSE: BRK-A) CEO Warren Buffett said in an interview Monday that he’s not buying shares of FAANG member Apple at this time, though it remains a major holding.

Insight From The “Oracle of Omaha”: Speaking of Buffett, he gave a wide-ranging interview yesterday on CNBC where he shared a lesson that might be useful for other long-term investors. Asked about Kraft Heinz Co KHC, which cratered last week after the company announced a $15.4 billion write-down, Buffett admitted BRK had overpaid for shares of KHC. However, he added he’s not selling. “We don’t pull the plug…” Buffett said. “It isn’t our style.” That doesn’t mean there’s never an appropriate time to give up on a stock, but if you still believe in a business—as Buffett apparently does in KHC judging from other comments he made in the interview—bad news and a major share drop don’t necessarily mean long-term investors should run for the exits. 

If a stock craters, it might be time to potentially reconsider why you own it in the first place and whether it still fits into your long-term plans. It’s also a chance to look more deeply into the company’s financials and its leadership to see if you still can find reasons to keep it in your portfolio or if you don’t believe in its future any longer. Fear tends to drive some investors into bad decision-making, so it’s important to allow cooler heads to prevail (including your own) before jumping to quick conclusions.

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