Washout: Stocks Continue to Sag After Falling Four-Straight Sessions

(Wednesday Market Open) The market didn’t get the memo that this was supposed to be a quiet week.

Instead, Monday and Tuesday saw steep losses for the major indexes, including the worst two-day stretch for the S&P 500® index (SPX) since November 1-2. That previous sell-off corresponded with the dates of the last Federal Open Market Committee (FOMC) meeting.

Perhaps not coincidentally, this dive comes just a week before the next FOMC meeting. The CME FedWatch Tool projects a 77% chance of a 50-basis-point rate hike, down from the recent series of 75-basis-point hikes.

Of course, we have two inflation reports to get through before the FOMC makes its rate decision—the November Producer Price Index (PPI) this Friday and the November Consumer Price Index (CPI) next Tuesday. Still, unless one or both reports come in surprisingly high, the Federal Reserve is very likely to stick with a 50-basis-point hike. That’s what it’s telegraphed very clearly, and it doesn’t like to surprise.

The market’s quick plunge Monday and Tuesday partly reflected concerns that the FOMC might hike the economy right into a recession. As bad as higher rates might be for Wall Street, a recession would likely be worse. Analysts still pencil in 5% earnings growth for 2023. A severe recession might turn that into a negative number, which could potentially imply that current stock prices are far too high.

The other factor in the sell-off is simply a news vacuum. The last major data we received was November’s monthly Nonfarm Payrolls Report on Friday and the ISM Services report on Monday. Both showed signs that higher rates haven’t done enough to slow down economic growth that can lead to more inflation. No fresh data during the last 48 hours has clearly left a bad taste in the market’s mouth with no distractions from those unpleasant memories.

Stock index futures are lower again this morning after falling the last four sessions.

Morning Rush

• The 10-year Treasury yield (TNX) is up slightly at 3.55%.
• The U.S. Dollar Index ($DXY) is down a fraction at 105.06.
• Cboe Volatility Index® (VIX) futures are up solidly from last week’s lows, at 22.83.
• WTI Crude Oil (/CL) rose marginally to $74.47 per barrel, remaining near 2022 lows.

Keep an eye on VIX today, as it’s rebounded solidly from lows below 20 last week. It’s knocking on the door of 23 this morning as stock indexes continue to sag.

Just In

• Soft economic news keeps dogging China. Earlier today, the country reported larger-than-expected drops in imports and exports for November, and shares there fell despite Beijing easing COVID-19 restrictions. That appears to be setting the tone for Wall Street early on.
• Campbell CPB is heating up after reporting a solid quarter and raising fiscal year 2023 guidance. Shares climbed nearly 4% in premarket trading. Sales rose 15% in the quarter, and that was mainly due to pricing, because volume fell 1%.

Bonds are Back

That’s the message from Charles Schwab’s Chief Fixed Income Strategist Kathy Jones. In a report Tuesday, Jones said 2023 looks to be the year that bonds will be back in fashion with investors.

“After years of low yields followed by a brutal drop in prices during 2022, returns in the fixed income markets appear poised to rebound,” Jones wrote. “It’s likely to be a bumpy ride due to the cross currents created by global central banks’ tightening policies, a volatile global economy, and ongoing political uncertainty here and abroad. Despite these challenges, we see opportunities in 2023 for the bond market to provide investors with attractive yields at lower risk than we’ve seen for several years.”

Jones bases her optimism about bonds on three factors:

• Starting yields are the highest in years—in both nominal and real terms;
• The bulk of the Fed tightening cycle is over; and
• Inflation is likely to decline.

Potential Market Movers

In a week without earnings fireworks so far, Thursday could light a fuse.

Several major companies are expected to report earnings Thursday, including Broadcom AVGO, LuLulemon LULU, and Costco COST. Anything in common here? Well, all three report after tomorrow’s close, but beyond that, it’s hard to find a lot of similarities. Looking individually:

COST already reported November sales, and the market didn’t apparently like what it saw, even though the number rose 5.7% from a year earlier. That was down from a 7.7% increase for October and a gain above 10% in September. Costco shares fell on the news, making tomorrow’s earnings report feel a bit like an afterthought. Keep in mind that Costco sales, like any big retailer, can reflect ups and downs in inflation, meaning current drops in gasoline costs might have an outsized impact. Something else to watch: the company’s margins, which took a hit last time due to higher costs. If supply chain issues have truly begun to ease, that could provide a margin tailwind. In addition, listen for any news on membership fees, which Costco hasn’t raised since mid-2017 despite some competitors doing so.

LULU reported strong earnings back in September, beating Wall Street’s expectations and is raising its outlook. Shares popped 9% on the day, according to LuLulemon. To match that sort of report, it has a very large pair of jogging pants to fill. If it does, maybe give the weather a credit. It’s been a colder-than-normal start to winter across parts of the country, and the snowpack out west is double the average amount in parts of the Sierras. That could be driving sales of the company’s outerwear like heavy jackets and boots. Or at least that’s what bullish investors probably hope. As with any retailer, inventory levels will be important to watch. Last time LULU reported, it sounded like it made strides getting supplies back to levels where tightness wasn’t an issue.

AVGO continues to work on its $61 billion merger with VMware, an IT infrastructure company, so look for updates on progress there. The idea behind the merger is to diversify AVGO’s business into enterprise software and beyond its core semiconductor business, but some analysts consider this a big bite to chew off and wonder if AVGO can be successful. Broadcom beat analysts’ estimates and gave strong guidance the last time it reported, but that was in early September before the Biden administration tightened chip sanctions on China. Shares went on a nice run starting in mid-October but leveled off recently.

Reviewing the Market Minutes

If there’s any doubt about the more cautious investor stance we referred to yesterday, check Tuesday’s final sector scorecard. The leading sectors were all “defensive” ones that tend to do better when there’s economic trepidation: utilities, real estate, consumer staples, and health care.

Here’s how the major indexes performed Tuesday:

• The Dow Jones Industrial Average® ($DJI) fell 350 points, or 1.03%, to 33,596.
• The Nasdaq Composite® ($COMP) slipped 2% to 11,014
• The Russell 2000® (RUT) dropped 1.53% to 1,812.
• The S&P 500 Index® (SPX) retreated 57 points, or 1.44% to 3,941.

Talking Technicals: While Tuesday represented another washout for the major indexes, it’s slightly constructive that the SPX charged back from the intraday low below 3,920 to close slightly above a technical support point some chartists saw at 3,940. Perhaps that sets up the market for technical buying today. It was also the fourth-straight day of losses for the SPX, something not seen since mid-October.

CHART OF THE DAY: LOWER LOWS. Though higher Treasury yields hurt Wall Street earlier this year, this three-month chart of the 10-Year Treasury yield (TNX—candlesticks), isn’t going to warm the hearts of market bulls. It shows a pattern of lower lows marked by a trendline that runs just below the current level, down near 3.45%. It might be interesting to see if that level holds in coming days, but if it doesn’t that could signal traders expect economic misery ahead. Data Source: Cboe. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Waiting for Santa Claus? We’re entering the time of year when many investors look for the so-called Santa Claus Rally—the market’s tendency to deliver outsized gains between mid-December and early January. According to the Stock Trader’s Almanac, it has occurred in about 75% of the years since World War II. Last year, despite the market’s ups and downs, it led to a nice end-of-year rally. But as soon as Santa retreated to the North Pole in early January, so did the market: January 4 was and remains the 2022 high.

This year, Fed Chair Jerome Powell may be the one driving the sleigh. While the Fed funds rate itself might not be the catalyst for any positive spin, according to CME Group’s FedWatch Tool, there’s a 77% chance of a 50 basis point hike, a 23% chance of the Fed hiking by a hawkish 75 basis points, and essentially zero chance of a more dovish stance. Powell’s remarks following next week’s post-FOMC press conference could offer some positive language on when the tightening cycle might be completed (his estimated “terminal rate”), or other words of reassurance like expectations for a soft landing. If not, this year’s stockings could be filled with lumps of coal.

Crude Gets a Flat: The futures market is supposed to tell you about, well, the future. Or at least the market’s current take on the future—and the futures market changes so quickly, it’s like the old joke about Chicago weather. If you don’t like it now, check again in five minutes. That may be true most of the time, but not now for WTI Crude Oil (/CL) futures.

You may hear about the futures market being in contango or backwardation, meaning future prices are higher or lower than the spot price. That’s normal. What’s abnormal is how /CL futures currently line up. The spot price is near $75 per barrel, and so are all the contracts for the entire next year, with no drops below $74 or jumps above $76 baked in. That’s rare for any futures market, let alone a volatile one like crude that can pivot quickly on changes in seasonal factors to geopolitics. Over the last year alone, /CL has gone all the way from $75 to $130 to $75 again. What we see now suggests traders—both commercial and speculative—believe supplies are roughly balanced, and that fundamentals won’t change much over the next year. Come back in five minutes if you don’t like it.

Claims Jumping: Tomorrow brings the weekly initial jobless claims data, which, for the most part, hasn’t satisfied those who’d like to see a slowdown that might soothe the Federal Reserve. If analysts are right, Thursday’s data won’t be any different, with consensus on Wall Street at 220,000, according to Briefing.com. Perhaps it’s more informative at this point to look at continuing claims, which topped 1.6 million last time. That brought the four-week continuing claims average up by 30,000 to 1.538 million. Remember, numbers can be jumpy week to week, so it’s worthwhile to keep an eye on the longer-term trend. The November PPI report is Friday morning, and we’ll preview the numbers tomorrow.

Notable Calendar Items

Dec. 8: Expected earnings from Broadcom (AVGO) and Costco (COST)

Dec. 9: November PPI and Preliminary December University of Michigan Consumer Sentiment Index

Dec. 12: November Treasury budget and expected earnings from Oracle (ORCL)

Dec. 13: November CPI, FOMC meeting begins, and expected earnings from ABM Industries (ABM)

Dec. 14: FOMC rate decision, quarterly projections and dot-plot, November Export and Import Prices, and expected earnings from Lennar (LEN)

Dec. 15: November Retail Sales, December Empire State Manufacturing, and November Industrial Production and Capacity Utilization

Dec. 16: Expected earnings from Accenture (ACN)

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

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