Fed Minutes Ahead Could Offer Insight Following Wall Street's Worst Day In A Month

“Buy the dip” is facing its toughest test in a month. 

If you think back to mid-July, the major indices tanked as concerns about the Delta variant and Fed tapering ramped up. The same factors helped set off the market’s worst drop in four weeks Tuesday and could keep investors on their toes again today as they await Fed minutes for any insight into a possible stimulus taper. The question is whether people will step in again to buy at lower levels. 

That’s what helped the market recover from mid-July jitters to August record highs, and it seemed to be in place Monday and Tuesday when the market recovered from early weakness both times. Still, a lot weighs against people who want to buy here. You’ve got to go against the grain, so to speak, because a bunch of factors—yields, gold, volatility—are flashing yellow lights. 

Discretionary Stocks May Deserve An Apology

Data’s another yellow light flashing, with a lot of focus first on last week’s soft consumer sentiment followed by some disappointment over Home Depot HD yesterday and of course, a drop in July retail sales. 

The damage done yesterday to HD and other Consumer Discretionary stocks, however, might be getting overdone. That means the sector could have a decent chance to come back a bit, if and when people think through the bigger macro picture. A lot of the weakness in Tuesday’s retail sales report reflected the automobile sector, so you need to look at the number with autos taken out of the equation to get the full picture. Car companies have problems of their own right now with supply thanks to the chip shortage.

Also, just because people didn’t spend as much at stores, according to the report, doesn’t mean they’re not spending. They just could be spending on different things. It’s August and people are anxious to be on vacation, Delta variant or no Delta variant. The national parks were so crowded this summer that some of them had to turn people away. Also, bar and restaurant sales looked stronger in July than the previous month, according to yesterday’s data.

Basically, people got off track from that one number yesterday (retail sales), and even the HD numbers weren’t necessarily as bad as people made them out to be. Assuming for a moment that HD isn’t seeing demand, that doesn’t mean some of the other Consumer Discretionary companies, say, for instance, McDonald’s MCD, aren’t. E-commerce has struggled a bit, and that affected Walmart WMT, but a lot of that is a reflection of people wanting to get back outside. If they’re at Yosemite, let’s say, they’re probably not at WMT that day. 

The other thing to keep in mind about e-commerce, in general, is that comparisons are very tough vs. a year ago when it was just about the only game in town, so to speak. Some stores were open by this time last year but on a limited basis. Now the online stores have to compete again with brick and mortar. One question is how mask mandates coming back in some cities like Chicago might affect that.

From Afghanistan To Suburban Driveways

We’ve kind of gotten away from the other big story dominating newspapers and TV early this week: Afghanistan. It’s a terrible situation for the U.S. troops, allies, and many other people who are still there, but as far as the markets go, we’ll have to wait and see on the longer-term implications. The market had a lot to grapple with Tuesday and foreign affairs didn’t appear to be a major factor. 

It’s often said that Afghanistan is a place where powerful countries get hurt again and again. That may be true, but it doesn’t necessarily follow that it has a market impact. The region isn’t all that important economically, and the population of Afghanistan is about the size of Canada’s and not a major importer. Obviously, that’s not to discount the tragic circumstances going on. 

Back on the home front, pun intended, homebuilder stocks took it on the chin yesterday after a soft reading on homebuilder sentiment. Stocks like Lennar LEN, Toll Brothers TOL, KB Home KBH, and D.R. Horton DHI played defense. 

It hasn’t been a great summer for the sector as high materials costs squeezed margins and high home prices appeared to hurt consumer demand for new homes. However, some things may remain in the sector’s favor, including historically low mortgage rates and the huge recent drop in the price of lumber. Though lower-income home buyers may be facing affordability troubles, the homebuilders who cater to higher-end customers may not feel the heat as much. There are still bidding wars in parts of the country. 

On the other hand, it would be nice to see the first-time buyer have a better chance at getting a home of their own, something that’s gotten more and more difficult. There’s not a lot of relief from the rental market, where prices are also up. Data-wise, housing starts and building permits for July came in pretty close to expectations this morning. Starts missed consensus views, but permits were above analysts’ estimates. 

Small-Caps May Be Trying To Tell Us Something

From a historical perspective, small-cap stocks like some of the home building companies often steer the wheel for the broader market. If that’s the case now, it doesn’t look like a direction bulls will be comfortable going. The Russell 2000 (RUT) index of small caps had another day yesterday where its losses were the worst of any of the major indices (see chart below). 

The S&P 500 (SPX), meanwhile, recovered from its heaviest losses Tuesday, so maybe a little “buy the dip” explains that. On any moves sharply to the downside from here, keep an eye on the 50-day moving average near 4341. The 50-day has been a regular bouncing point for the SPX most of this year, including the last time the market had a major hiccup in July. 

That hiccup had a lot to do with the Fed, and today we get another chance to see what the central bank is thinking. Fed minutes from their July meeting are due this afternoon and could give some insight into any possible plans on taper timing.

Volatility might spike a bit around the time those come out, with a lot of people more focused than usual on what Fed officials might have discussed and how they framed things. So be especially careful if you’re trading around that time, and consider keeping your trade sizes a bit lower than usual if you’re worried about turbulence. There’s a lot of talk that the Fed might announce a tapering schedule at its Jackson Hole symposium next week, which could explain some of the rising volatility this week. 

Yesterday was a very orderly selloff, which is usually a positive sign. Still, with an orderly selloff, you have to watch for follow-up selling in the next week. There may be one more day of selling to come, but not necessarily today.

CHART OF THE DAY: BIG DROP FOR SMALL CAPS. While Tuesday’s selloff was pretty broad based, the small cap benchmark Russell 2000 (RUT—candlestick) was hardest hit, falling 1.3%. After leading the charge in early 2021, the RUT has become the laggard. For example, the S&P 500 (SPX—purple line) has made numerous new highs this summer, whereas RUT topped out back in March. Data sources: S&P Dow Jones Indices, FTSE Russell Indexes.  Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Retailers Keep Cash Registers Ringing: Even if the market is flat, there’s plenty to occupy us this morning. Target TGT earnings this morning and Nvidia NVDA after the close are two of the main events other than the Fed minutes later this afternoon. Last time out, NVDA had very strong sales in its data center and video game businesses and delivered an upbeat forecast. They also talked about supply constraints lasting into the second half. Today offers a chance to see whether those trends made it to mid-year. 

TGT earnings looked really solid, but the stock fell in pre-market trading. The same thing happened to WMT yesterday but the stock clawed back. Comparable sales for TGT rose almost 9% on top of record growth a year ago. It’s a bit of a head-scratcher to see the stock under pressure, because looking at the report, it’s hard to find anything wrong. 

The stock market aspect of the story was different over at Lowe’s LOW, where shares bounded ahead by 4% in pre-market trading. HD hinted at it yesterday and LOW spelled it out today: A year ago people had nothing to do but the garden and other home improvements to get outside as we were stuck at home. These days, it’s the professional re-modelers who are picking up the pace. TJ Maxx TJX also had a good report. The retailers are actually doing all right. 

With Earnings Season Winding Down, Next One In View: As Q3 continues, analyst estimates for Q3 aren’t climbing as quickly as estimates did in Q1 and Q2. That could change, but it might be a good thing to keep optimism in check a bit ahead of the next earnings season because companies for the most part are going to face tougher comparisons. Remember that by Q3 of last year, the economy was in recovery mode and we weren’t all locked in our homes.

On the bottom line, research firm CFRA expects Q2 earnings per share growth of 86.7% for the S&P 500 to slow to 24.8% in Q3. For 2021 as a whole, the firm sees nearly 40% EPS growth, dropping dramatically to less than 9% in 2022. We’re moving from an era of some of the easiest comparisons ever to some of the toughest. This may be one reason for some of the hesitation in the rally lately. 

More Explanations For Low Yields: Yesterday we shared one theory about why Treasury yields remain stubbornly low as fixed income rallies despite the Fed making noises about possible stimulus tapering. The theory suggested that investors see tapering as a way the Fed can provide a longer runway for the economy before actually raising rates. Another couple of theories are out there, too.

One is that U.S. yields continue to offer more to investors than overseas ones, attracting bond buyers from Europe and Asia. Another, shared by a guest on CNBC Tuesday, is that pension funds are cashing out of stock market positions after the long rally and parking their profits in fixed income, which they may see as less risky with stocks at all-time highs. Obviously, there’s no position in the markets without risk, but there are signs of risk aversion all over the place, with volatility moving higher this week and gold also in rally mode. The 10-year yield put on a little weight this morning and rests near 1.27% ahead of Fed minutes. Watch its direction after that news comes out.

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

Image by Alessandro D'Andrea from Pixabay