Climbing the Wall: As Wall Street Considers Fresh Worrisome Economic Data, Stocks Head Lower

(Thursday Market Open) Yesterday’s steep sell-off looked like it might be a wake-up call as earnings season accelerated. This morning’s trading picked up where Wednesday left off, with stock index futures losing more ground amid bubbling recession concerns.

December Retail Sales data, released Wednesday, turned out to be a real eye opener. Investors were used to weakness in rate-sensitive areas like housing and automobiles. Now, softness appears to be at the mall, which means it’s likely spreading into the broader economy.

While “bad news is good news” helped fuel the late-2022 rally, Wall Street now seems concerned that bad news might actually be bad news, especially with the Federal Reserve still expected to raise rates when it meets in less than two weeks.

St. Louis Fed President James Bullard sounded hawkish in remarks on Wednesday. Then JP Morgan Chase (JPM) CEO Jamie Dimon told CNBC this morning, “I actually think rates are probably going to go higher than 5%” because “there’s a lot of underlying inflation which won’t go away quick.”

Earnings are now the wild card. It’s not just the Q4 results, but company outlooks and what executives say on their calls. If margins are getting squeezed and customers are pulling back, it could fuel concerns that even recent bearish analyst estimates for a 3.9% drop in Q4 earnings (according to FactSet) could be too optimistic. It seemed like Wall Street might be baking in that perception.

Morning Rush

• The 10-year Treasury yield (TNX) rose 3 basis points to 3.41%.
• The U.S. Dollar Index ($DXY) is flat at 102.3.
• Cboe Volatility Index® (VIX) futures rose sharply to 21.61.
• WTI Crude Oil (/CL) dropped 0.8% to $78.87 per barrel.

The $DXY remains near recent lows after yesterday’s Wall Street sell-off. The dollar’s struggles could be a positive sign of growing investor faith in overseas economies. Or of U.S. recession fears. Take your pick.

The falling yields we’ve seen recently certainly lent support since the October trough in major stock indexes. Still, some analysts worry that the very thing fueling the drop in yields—softening inflation—could cause trouble for stocks as companies lose pricing power that propped up margins last year.

Rising margin pressure is one possible reason for layoffs. Microsoft MSFT became the latest info tech company to announce layoffs Wednesday, with 10,000 job cuts, following Amazon AMZN announcing an 18,000-employee layoff earlier this month. Meta META laid off 11,000 in November. Alphabet GOOGL also recently announced layoffs.

For MSFT and AMZN, this goes beyond margins. With both companies seeing cloud demand come down to earth in their most recent earnings reports, MSFT cited “caution” from organizations (meaning customers) as one reason for their layoffs. MSFT is expected to report next Tuesday, followed by AMZN on February 2; the health of their cloud operations will likely be closely watched.

Just In

December Housing Starts and building permits data this morning showed softness in the housing market continues. December starts fell to a seasonally adjusted 1.382 million, below a revised November figure of 1.4 million. Building permits also fell and came in below expectations at 1.33 million. Analysts had expected starts of 1.35 million and 1.37 million, respectively.

These numbers, however, mostly don’t reflect the pick-up we’ve seen since mortgages started to fall in late December. Yesterday’s weekly mortgage applications data looked solid.

There’s no sign of any slowdown in the jobs picture this morning. Weekly initial unemployment claims of 190,000 were near recent lows and well below Wall Street’s expectations for 212,000.

Stocks on the Move

Netflix (NLX): Analysts expect EPS of $0.45 and revenue of $7.82 billion for streaming giant Netflix (NFLX), scheduled to report after today’s close. NFLX set an aggressive goal for Q4 subscriber growth at 4.5 million, so we’ll see if it came close. It also said it expected foreign currency to hurt its operating margin.

Don’t expect quarterly subscriber growth estimates from NFLX today. It plans to stop reporting them. This could mean a bit less volatility in the stock, and perhaps is a reminder of several years ago when Apple (AAPL) changed its quarterly reports to no longer report the number of iPhone units sold. Things are getting less granular, arguably because companies got burned too many times by trying to share and predict exact numbers on key metrics.

Procter & Gamble (PG): Speaking of shoppers, shares of the consumer products company fell 2% in premarket trading despite EPS and revenue that met the Street’s expectations. PG also reaffirmed 2023 EPS guidance and raised 2023 revenue guidance. It’s just one earnings report, but if this is how the market is going to treat companies that make their numbers, we could be in for a long reporting season ahead. And companies that miss expectations can likely expect even worse treatment.

Talking Technicals

The S&P 500® index (SPX) nearly had an “outside” day on the charts, where the day’s high is higher and its low is lower than the prior day. It came within one point of Tuesday’s high before descending well below Tuesday’s low to post its lowest close in more than a week. This can be the kind of chart reversal that picks up momentum beyond a single day.

However, volume yesterday was well below normal, meaning the sell-off may not have much conviction.

It’s easy to lose heart after a day like Wednesday, watching a week’s rally get erased in a few hours. Try to keep things in perspective, though. Earlier this month, the SPX was still trying to claw back above 3,800, and it remains well above that. Levels to watch today include 3,915 as possible resistance, with 3,900 and 3,880 as potential support points.

Reviewing the Market Minutes

The 4,000 mark remains thin air for the SPX, which continues to struggle every time it narrowly eclipses that big round number. One reason is that 4,000 is a clear signal of the SPX moving above its historic average price-earnings (P/E) level of 17. Though analysts differ on how S&P 500 earnings will ultimately look in 2023, right now a move toward 4,050 would put the SPX near 18 for forward P/E, a level the index historically has trouble staying above, according to one analyst on CNBC yesterday.

No sector escaped the quicksand on Wednesday, but financials, consumer staples, utilities, and industrials performed the worst. One interesting thing was semiconductors outpaced the Nasdaq Composite® ($COMP) and the SPX, unusual on a day of such broad selling when many other growth sectors took it on the chin. Some tech mega-caps also did relatively well, though virtually everything finished lower.

Stocks taking big hits included staples like CocaCola (KO), PepsiCo (PEP), PG, and Clorox (CLX), all falling 2.5% or more on Wednesday. This could reflect concerns that customers might gravitate toward lower-priced generics if the economy slows and possibly that lower inflation could reduce their pricing power. Firms with exposure to agriculture like Deere (DE) and Conagra (CAG) also slumped.

Here’s how the major indexes performed Wednesday:

• The Dow Jones Industrial Average® ($DJI) fell 613 points, or 1.81%, to 33,296.
• The $COMP slipped 1.24% to 10,957.
• The Russell 2000®(RUT) dropped 1.59% to 1,854.
• The SPX fell 62 points, or 1.56%, to 3,928.

Three Things to Watch

It’s almost Chinese New Year, so today we’ll focus on a few China-related market developments and their potential impact.

The Long View: While China’s latest GDP figures Tuesday looked slightly better than analysts had expected, the nation noted some significant demographic headwinds that could significantly add to China’s longer-term economic challenges. Its national statistics office reported that China’s population shrunk last year for the first time since the nation’s historic famine six decades ago. This isn’t a complete surprise from one standpoint—the United Nations announced last year that India would likely overtake China as the world’s most populous country sometime in 2023. But The New York Times also reported national data Tuesday that by 2035 more than a third of China’s population will be over age 60. Despite cutting back in recent years on programs limiting birth rates, China will join developed nations in fighting similar problems linked to aging populations—dwindling labor pools and consumer demand, with heavier spending on health care and pension systems. This could have ramifications across the global economy, especially on future demand for crude oil, minerals, and other products.

The Crude Case: It’s hard to account for WTI Crude Oil’s (/CL) 13% rally from its January 4 close unless you fully buy into scenario that China’s reopening means its economy has truly bottomed. China’s 2022 GDP growth of 3% last year was down sharply from above 8% in 2021 and was the weakest non-pandemic-year GDP for the country in decades. It’s possible we’ve seen the worst for China, according to some analysts. For instance, the World Bank thinks China’s GDP will grow 4.3% this year, though that’s down from a previous estimate above 5%. Growth could get a boost from China’s government, which according to analysts appears ready to cut taxes and lend support to entrepreneurs. It might take some fiscal firepower to kickstart China’s manufacturing activity, which fell quarter over quarter in Q4. That doesn’t bode so well for crude demand. Another thing that doesn’t bode well for demand, at least in the immediate future, is the holiday shutdown of China’s markets between January 23 and January 27 that will likely suppress manufacturing activity during that period.

Still at Odds: The United States and China have avoided a “hot” war for decades despite tension over Taiwan. However, the cold war they’re fighting is economic. According to American Enterprise Institute (AEI) senior fellows Dan Blumenthal and Derek Scissors, the United States could find itself more vulnerable to Chinese competition in the coming years. In a recent article in The Atlantic, the pair said China’s government is beefing up the country’s preeminent position in global supply chains, meaning the United States could depend even more on China for crucial materials used to manufacture electric vehicles, biopharmaceuticals, and lower-end semiconductor chips. China also is intent on bolstering its aerospace industry, potentially hurting U.S. and European firms in an industry that traditionally sell planes to China. This strategy could ultimately give China even more leverage over the U.S. economy, because if at some point the United States does something Beijing dislikes, “China may simply stop the supply of crucial goods in these sectors,” they wrote. The United States is trying to bring more industrial production back home, but even the CHIPS Act of 2022 that seeks to reduce U.S. dependence on Asian chip production seems like a small step. The United States relies on East Asia for 75% of global chip production, and analysts expect production of the most advanced chips to remain in Taiwan, vulnerable to Chinese interference.

Notable Calendar Items

Jan. 20: Existing Home Sales and expected earnings from Schlumberger (SLB) and State Street (STT)

Jan. 23: Expected earnings from Baker Hughes (BKR) and Steel Dynamics (STLD)

Jan. 24: Expected earnings from Johnson & Johnson (JNJ), Lockheed Martin (LMT), General Electric (GE), 3M (MMM), Union Pacific (UNP), and Verizon (VZ)

Jan. 25: Expected earnings from Abbot Labs (ABT), Boeing (BA), AT&T (T), IBM (IBM), Tesla (TSLA), and Whirlpool (WHR)

Jan. 26: December Durable Goods and Durable Orders, Q4 GDP (first estimate), December New Home Sales, and expected earnings from American Airlines (AAL), Master Card (MA), Southwest Airlines (LUV), Dow Chemical (DOW), Alaska Air (ALK), and Blackstone (BX)

Jan. 27: December PCE Prices, Final January University of Michigan Consumer Sentiment, and expected earnings from American Express (AXP) and Chevron (CVX)

Jan. 30: Expected earnings from GE HealthCare (GEHC)

 

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