Pogo Stick: Drop, Rebound, Repeat as Direction Seems Hard to Find Ahead of Earnings

The traditional start of earnings season is just two days away, and in the meantime Wall Street has its eyes on events in Washington and a pretty mild inflation reading. Crude is up and small caps have been leading the charge lately.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Volatility ahead of vaccine rollout, stimulus
5 min read
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Key Takeaways

  • Search for direction continues, with Wall Street likely to eye events in Washington

  • Yields pull back following strong auction demand, Fed officials’ dovish comments

  • “Risk-off” seems to be the word of the day with market bracing for bank earnings Friday

(Wednesday Market Open) If you’re looking for direction, buy an atlas but don’t ask Wall Street. 

The market continues to bounce around like a pogo stick this week as investors search for some kind of catalyst. It could arrive as soon as Friday when three of the biggest banks are scheduled to report earnings. 

For now, there’s less to chew on from a corporate perspective—which means that events in Washington could continue to drive trading. Today brings what political analysts expect to be the second impeachment of President Trump in a little over a year. With the D.C. situation so unsettled one week before a new administration takes office, some of that uncertainty might hit the market. Stocks were in the red leading up to Wednesday’s opening bell following Tuesday’s turnaround. 

Treasury yields are also in the red this morning after a 10-year auction brought strong demand yesterday and two Fed officials hinted that it’s too early to think about slowing the pace of bond purchases. Later this month that’s probably going to be a question Fed Chairman Jerome Powell faces at his press conference following the Federal Open Market Committee (FOMC) meeting. 

Meanwhile, volatility is up slightly but nothing too alarming. It does feel like there’s a bit more of a “risk-off” scenario in place this morning, and even yesterday’s rally wasn’t exactly convincing. The market spent most of Tuesday trading either side of unchanged before finishing with a flourish. Major index futures started to come back a bit ahead of the opening bell and crude continues to edge higher on supply concerns. 

Despite Electric Competition, Energy Powers Higher

It’s kind of ironic that on Tuesday, the day General Motors (GM) unveiled its latest autonomous vehicle and even a flying car at the Consumer Electronics Show (better known as CES), Energy stocks surged and the price of crude hit 11-month highs above $53 a barrel.

If the future of driving is autonomous and electric, you wouldn’t know it looking at some Energy stocks and their performance on Tuesday. The sector as a whole rose more than 3%, and stocks like Occidental Petroleum (OXY) and Apache (APA) climbed double digits. 

Energy as a sector is down 30% over the last year but up 37% over the last three months, an epic turnaround. This is happening despite what analysts expect is going to be a pretty ugly earnings season for many of the sector’s companies. Research firm CFRA predicts a 101% year-over-year Q4 earnings drop for S&P 500 Energy firms and a 62% decline in Q1.

The excitement around cyclical sectors like Energy and Financials—which rose 1% on Tuesday on leadership from Goldman Sachs (GS)—centers around growing hopes that the U.S. might be getting over the virus hump as vaccinations climb. Expectations for pent-up demand possibly returning after the pandemic are helping lift sectors that tend to shine in a recovering economy.

At the same time, rising Treasury yields have begun to weigh a bit on the big growth stocks, including many in Technology. The 10-year yield scooted out to big gains early Tuesday that briefly took it to a new 10-month high of 1.19% before easing back to 1.13% to end the day and to 1.12% by this morning. These aren’t historically high by any stretch of the imagination, but there’s growing concern that if rates keep rising, they could take some starch out of earnings growth and maybe start to compress a few of the high multiples we currently see. Many of those high multiples are in the Communication Services and Info Tech arenas. 

Stronger Yields, Stronger Energy Sector

Climbing yields send a different message to banks and oil companies. For investors there, it’s a welcome relief that speaks to possible growth in the economy and better Financial sector profits. The key 10-year/two-year yield curve recently rose to levels last seen in 2017, typically a bullish indicator for banks. Some banking firms, including GS and JP Morgan Chase (JPM), have seen their stocks eclipse previous pre-pandemic highs recently. Some bank and Energy stocks got upgraded yesterday, which also helped the two sectors. 

Bank earnings season begins later this week. Though many analysts expect overall industry profits to fall in Q4, they also see a lot of green shoots like resumed stock buybacks and possible declining loss reserves giving the sector some fuel. 

Fuel or no fuel, as the case may be, GM rose more than 6% Tuesday and also reached new post-pandemic highs as excitement grew about its position in the electric vehicle (EV) space. GM is seen by some analysts as an industry leader in autonomous vehicles and EV, which could be a big catalyst in years to come. GM is also working on personal aircraft. While it may seem like a bit of a long shot, people laughed at the Wright Brothers, too. 

Ford (F) also had a strong day yesterday, and it’s interesting to see the car makers starting to get some credit for what they’re doing. These companies used to be driving forces in the market, so seeing them lead the charge here feels like what’s old is new again. 

Despite GM’s and F’s turn in the spotlight, Tesla (TSLA) resumed its amazing run Tuesday after a Monday slump, rising nearly 5%. Some analysts think TSLA’s price move is partially driven by changing investor perceptions of the company. They see it not just as an electric car maker, but also as an energy storage firm. Its huge rally has also removed some of the financial constraints TSLA used to live with, potentially giving it more flexibility on the capital side.

Meanwhile, Chinese EV maker Nio (NIO) stepped back yesterday but has raced the stock market equivalent of zero-to-60 over the last year, rising from around $3 a year ago to $62 on Tuesday. 

Also, KB Home (KBH) shares rose sharply after the home builder beat Wall Street’s earnings and revenue estimates when it reported late Tuesday. On its earnings call, KBH leadership called housing market conditions “robust” and said the pandemic has fueled demand for home ownership. One interesting thing KBH noted was a rise in the percentage of first-time home buyers in Q4. KBH, like other home companies, suffered during the pandemic, but it was kind of a double-edged sword for them because they tend to not be in cities, but in open areas where people want to be now, so they’re getting some benefit.

Back to Basics

Data is finally back in the news today after a couple days without much to talk about. Today’s consumer price index (CPI) report for December showed a gain of 0.4%, right in line with consensus, and an uptick from November’s 0.2% increase. Core CPI, which strips out food and energy, was pretty mild at 0.1%. Inflation’s been a popular topic lately considering the quick rise in the 10-year yield, so consumer prices might be a number to watch in 2021. The producer price index for December comes out Friday, along with retail sales. We’ll preview retail sales tomorrow morning. 

Later today, the crude market comes back into focus as weekly U.S. supply and production data bow. The previous week saw an 8 million barrel decline, extending a recent pattern of falling inventory. It’s kind of odd to see that around this time of year, when driving is typically near its low point. 

Also, the pandemic continues to keep air traffic down. Some of the rally might reflect a lot of money on the sidelines getting plowed into commodities in general, not just crude. Copper prices rose 26% last year. The recent Saudi Arabian production crude output cut announcement and the soft dollar might also be keeping crude prices supported.

philadelphia semiconductor index

CHART OF THE DAY: RACE FOR THE TOP. Both the Dow Jones Transportation Average ($DJT—candlestick) and the Russell 2000 Index of small-caps (RUT—purple line) are chasing each other for upside leadership over recent months, reaching new highs. Both have been propelled in part by rising energy prices, higher bond yields, and growing hopes of pent-up consumer demand returning after the pandemic. Data Sources: FTSE Russell, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Air and Water Show: Utilities stocks often fly under Wall Street’s radar, perhaps because the sector isn’t too sexy and doesn’t include any of the “mega-cap” stocks that grab headlines. Over the last year (and the last month), it’s one of the few sectors in the red, pulled down in part by many Utilities companies having close ties to the even worse-performing Energy sector. A couple of factors might keep the struggle going in weeks and months to come. First, rising Treasury yields could draw investors away from seeking yield in the stock market and back into fixed income. Yields remain historically low, but some analysts see the potential for 1.5% or even 2% in the 10-year Treasury at some point this year. Utilities stocks with high yields traditionally are seen as “bond proxies,” but their luster can wane when investors find similar yields in government and corporate bonds.= 

Then there’s the new administration taking office next week. The last time a Democrat occupied the White House, renewable energy received government support over traditional energy sources. If that’s the case again, it could have negative implications for some of the natural gas, nuclear, and pipeline-related Utility companies, though it’s potentially positive for Utilities that appeal to some investors’ Environmental, Social, and Corporate Governance (ESG) preferences by offering wind and solar energy. Some large Utilities firms have exposure to both traditional and alternative energy and may be better positioned to benefit if the Biden administration starts a new move toward “green” initiatives. 

Speaking of Water: Cruises are back. Well, not right now, but it’s looking good for 2022. “We are seeing good demand in all of the various cruise markets, whether it be Caribbean itineraries, Europe itineraries, there is good demand for Australia, world cruises, etc.,” Carnival (CCL) CFO David Bernstein told investors on a call this week, according to Travel Weekly. The company said that bookings for the first half of 2022 were already set to outpace the number of bookings made for the first half of 2019, and that the company has enough cash to survive 2021 even if it can’t run any cruises this year. Other industry watchers have also cited continued strong demand for cruise vacations once they’re possible again, especially among young people.

However, the industry remains basically in dry dock and completely dependent on the virus situation improving. You might remember last spring when these companies expressed optimism about 2021. Not their fault, of course, but it’s 2021 and no one is cruising the high seas. There’s also some concern about whether people who’ve found other vacation spots during the pandemic—all-inclusive resorts, for instance—might choose those instead in the future. CCL and Royal Caribbean (RCL) shares, like their ships, continue to go nowhere fast. 

Delta First Out of Gate: Since we’re talking travel, it seems only natural to bring up airlines—especially with Delta (DAL) scheduled to be the first big airline reporting earnings tomorrow. The sector got a little wind under its wings between mid-November and mid-December as holiday travel expectations surged, and some of the travel numbers in late December looked pretty good. Now airline stocks are slumping again (though they did climb Tuesday) amid the weight of new virus cases and continued lack of business travel. It’s the latter issue that could really hurt DAL, which analysts expect will post a loss of $2.50 a share in Q4. DAL is a leader in corporate travel, and many analysts believe that’s the type of travel that could be the last to fully recover, if it ever does. 

Those 40-minute presentations people used to fly 3,000 miles to deliver in person are now more likely to be done over the internet—even once the pandemic subsides. New corporate habits tend to take a while to develop, but once in place, they’re hard to change. Corporate travel remains down 85%, according to Cowen, and slower than expected vaccinations are one factor working against any near-term airline recovery. One question going into tomorrow is how much money DAL continues to “burn” each day during this prolonged travel slump. DAL made progress cutting that number in Q3, but how much deeper it can go remains unclear. DAL fell short on Q3 revenue and earnings Q3 compared with analysts’ expectations.

Good Trading, 

JJ

@TDAJJKinahan

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This week’s economic calendar. Source: Briefing.com
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Key Takeaways

  • Search for direction continues, with Wall Street likely to eye events in Washington

  • Yields pull back following strong auction demand, Fed officials’ dovish comments

  • “Risk-off” seems to be the word of the day with market bracing for bank earnings Friday

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