It's Not All COVID-19 And The Fed: Lululemon Reports After Close, And Airline Stocks Dive

(Thursday Market Open) Pull out the boots and jackets. It might be June, but it’s kind of ugly out there.

Stocks played defense in U.S. pre-market trading and overseas early Thursday as investors examined rising COVID-19 case numbers and many economists began calling the Fed’s economic outlook yesterday pessimistic. 

We’ve been talking about the optimism trade for a while, and it just ran into some facts. Everyone is blaming the Fed, but it was in a tough spot yesterday with the market back so quickly. What were they going to say after this great rally? That the market had recovered? That would have been disingenuous. 

The facts are we’re not fully reopened and businesses aren’t all the way back. The airline stocks were trading back at the same levels as before the crisis, even though the companies said they were hoping to be at 60% capacity. Basically, the market got out a little over its skis.

Also, you might remember a few weeks ago when we talked about the middle of June being a possible point of reckoning. The question was whether there would be a second wave of the virus. With states reopening in mid-to-late May, it seemed likely that we might see some data around now showing progress or lack of progress, both with reopenings and virus cases. The most recent data from some of the early reopening states didn’t look too positive on the virus front, and that’s being reflected today, along with pessimism around what the Fed said. 

Many people are casting the Fed’s words in a bearish light. The Fed plans to keep rates at basically zero through 2022, which doesn’t exactly show a lot of confidence in any quick comeback. However, you could make a counter-argument that low rates over extended periods have historically been bullish for stocks, though the past doesn’t necessarily guarantee anything in the future. 

The Fed noted yesterday we could face a “long road back.” The market was trading lately like the road might be as short as the walk from the driveway to the front door. It’s not that easy.

Bonds soared early Thursday and so did gold, with many people piling back into so-called “safe havens.” The 10-year Treasury yield, which flirted with 0.9% last week, is back below 0.7%. Lower yields tend to reflect investor caution.

Today could be a reminder that the epidemic is far from over, and that stocks remain extremely sensitive to headline news on this subject. Anyone who saw what happened to the airline stocks yesterday as worries about the virus began climbing knows what “sensitive” means right now.

This doesn’t necessarily mean the rally is over or that we’re starting some kind of terrible selloff. It’s normal for rallies to pause a few times in the middle and sometimes track backward for a few days. However, these aren’t normal times, as we all know. That’s what can make this such a tough market to figure out.

Trying to find some possible technical support levels? We might see a little bit between 3080 and 3100 for the S&P 500 Index (SPX). To put things in perspective, even a fall back to 3080 would put the SPX up about 40% from its late-March lows. If it can hold levels like that, this would remain a very firm rally.

Risk Horsemen Back in Saddle

While there’s no way to predict the future, the markets try to every day. Earlier this week, gold, bonds, and volatility—sometimes called the “three horsemen of risk”—began climbing. This could have been the market sending an early warning that things were about to get rough. That’s why it’s so important for investors to monitor these metrics.

The cyclical sectors like travel and restaurant stocks had generally done well lately amid reopening optimism. If there’s even a hint that the reopenings have to slow down or that progress against the virus is losing ground, we could end up seeing more of this cautious trading that appears to favor “stay-at-home” stocks like the FAANGs (almost all of which were up yesterday, incidentaly, though Facebook, Inc. FB retreated following Tuesday’s sharp gains).

On a positive note, Johnson & Johnson JNJ announced it’s moving its COVID-19 vaccine trials to a July start, which is two months sooner than previously expected. Strength in pre-clinical data caused the change, J&J said. It’s probably going to be a while until any results go public, so consider watching out for this later in the year. 

On the more immediate front, today brought a fresh round of initial jobless claims, and the number looked relatively good if you compare it to recent weeks. The number fell to 1.542 million, down from nearly 1.9 million a week ago and below the Wall Street consensus estimate of 1.6 million. While you never want to see over a million new claims, this trend continues to be lower and that’s a good sign. 

Later today, investors might want to gear up for lululemon Athletica, Inc. LULU results after the closing bell. Also on the earnings beat, Starbucks Corporation SBUX shares took a spill Wednesday after the company said it expects quarterly sales to decline as much as $3.2 billion due to the coronavirus. SBUX shares fell 4%.

Rally Takes a Pause, but For How Long?

The S&P 500 Index (SPX) is sputtering, which doesn’t feel good if you’re long the market. Still, it could be argued that it’s healthy to see a bit of consolidation after this long rally, because nothing goes straight up forever. This is the kind of pullback often seen in the middle of long rallies, though there’s no way to predict whether the market has more upside from here. 

Some analysts say things might have come too far, too fast. Yesterday’s slump in the Financial sector, if it continues, might support that theory because Financials often drive the market. Bank stocks slid after the Fed made it clear it plans to keep interest rates at current levels near zero through 2022. Other than Energy, no sector had a worse day than the banking industry yesterday.

Lower interest rates tend to weigh on profit margins for the banks, though they also tend to stir up demand for automobiles, mortgages, and other big purchases—which can be helpful for the industry (see more below). Next month when the major banking firms report could offer investors a look inside the columned walls of the banking business with executives potentially facing questions about the long-term impact of this weak rate environment.

Yields Retreat Unevenly

The 10-year Treasury yield is now down about 20 basis points from last week’s flirtation with 0.9%. The yield was already falling before the Fed meeting yesterday, and the Fed’s dovish prognostications helped the bond market find more buyers, apparently. Remember that yields fall when the underlying price rises.

Damage was less severe in 30-year yields, maybe a reflection of the fact that the Fed asset purchases mainly are in short-term fixed income products. The 30-year remains slightly above 1.5%, giving it about a 75-basis point premium to the 10-year. The more closely watched 10-year/two-year spread did narrow a bit yesterday, however, which is sometimes seen as a bearish economic indicator. It had been rising for weeks.

CHART OF THE DAY:  YIELD, VOLATILITY HEAD OPPOSITE WAYS: For the last week or two, the 10-year Treasury yield (TNX—candlestick) and the Cboe Volatility Index (VIX—purple line) have been trading different directions. When VIX was falling last week, the yield rose amid investor optimism about the economy. As yields swung south this week due in part to a dovish Fed, VIX started to gain some steam. This is arguably a bearish-looking chart for stock market investors. Data Source: Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

10000 Party for Nasdaq: When the Dow Jones Industrial Average ($DJI) first charged through the 10000 barrier in the spring of 1999, the Nasdaq (COMP) was trading near 2300. The Nasdaq stampeded above 5000 by 2001, only to fall back and linger below that level for more than a decade through two recessions. It took another recession and a pandemic, but finally the COMP has made it to 10000. It closed above that on Wednesday for the first time ever as Information Technology stocks rose about 1.7%. That was the only sector in the green Wednesday, an interesting shift when you consider that the long rally saw leadership the last few weeks from value and cyclical stocks. 

The Signal and the Noise: It’s a well-worn phrase within this column: One data point isn’t a trend. In the wake of the COVID-19 pandemic, perhaps that’s true now more than ever. COVID was one of those once-in-a-blue-moon events that changed everything—virtually overnight—with the jobs market in particular focus. Ten years of incremental gains in nonfarm payrolls, wages, and labor participation were undone between February and April. And then there was last week’s data, which showed a gain of 2.5 million jobs—versus consensus estimates pointing to a loss of 8 million. It’s worth reminding that, with all of the variables going into the data—unemployment applications sometimes flooding the systems, questions as to the permanence of job losses, the impact of Federal programs on employment dynamics, to name a few—it’s likely the data in the next several employment reports could be wonky by historical standards. It’s important to not overreact to any one number.

Thigh-High: Despite the huge rally since March, it’s possible more money remains on the sidelines. That’s the impression you might get looking at the May reading of the TD Ameritrade Investor Movement Index® (IMXSM). It increased to 4.35, up 11.5%  from its April score of 3.90. The IMX is TD Ameritrade’s proprietary, behavior-based index, aggregating Main Street investor positions and activity to measure what investors actually were doing and how they were positioned in the markets. 

While any higher move in IMX could reflect a potential increase in retail traders’ exposure to stocks, keep in mind that a 4.35 reading isn’t historically high by any stretch of the imagination. The May reading is actually near the lower end of the historic range. So if you want to use the old “dipping a toe back in the water” analogy, it seems probable that retail investors are up to mid-thigh by now, but don’t have much danger yet of getting in over their heads.

Good Trading,

JJ

@TDAJJKinahan

TD Ameritrade® commentary for educational purposes only. Member SIPC.