The market starts Friday burdened by a long list of potential negative factors that could help snuff out yesterday’s late rally. The semiconductor space looks like it’s under pressure after more weak earnings, and news on Brexit and China trade looks bearish.
Brexit, Semiconductors, and tariffs all on list of factors potentially bringing pressure
Housing sector took a hit yesterday on more signs of weak demand
Stocks enter Friday down nearly 2% so far this week, and seem to lack momentum
(Friday Market Open) After a late rally yesterday, the market appears to be coming under pressure on multiple fronts Friday thanks in part to a triple-headed monster of Brexit, semiconductors, and tariffs.
The Brexit worries carried over from yesterday when British Prime Minister Theresa May dealt with resignations that analysts say might jeopardize not only her ability to carry a deal through Parliament but perhaps even her hold on power. Another carryover is the semiconductor situation, with that entire volatile sector potentially coming under pressure after disappointing Nvidia (NVDA) earnings hit the tape late Thursday (see more below).
Meanwhile, Commerce Secretary Wilbur Ross splashed cold water on China trade hopes by saying talks later this month between President Trump and China’s President Xi would be to set up a “framework” for future talks, and that the U.S. still plans to raise tariffs on China in January. The expected talks between the two leaders had represented hope of progress to some investors. Now, it might be time to reassess.
A fourth horseman today might be fallout from Thursday’s big hit to home builders after one major firm reported weak guidance for the first quarter of 2019 (see more below). Basically, it looks like stocks might have a struggle on their hands. It wouldn’t be too surprising to see more of a “risk-off” attitude, and Treasury note yields are falling this morning. The 10-year yield is at 3.1%, down from highs above 3.24% a week ago.
As the opening bell drew near, Fed Vice Chair Richard Clarida told CNBC that the Fed is close to the point of being “neutral” on interest rates and should base further increases on economic data, the network reported. Early last month, Fed Chair Jerome Powell said rates are “a long way” from neutral. A “neutral” Fed funds rate is when the level is neither accommodative nor restrictive, but economists don’t agree on where that might be. The current target range for the Fed funds rate, set at the Fed’s September meeting, is 2% to 2.25%, and the futures market points toward strong chances of another 25 basis-point hike next month.
The earnings season continues to pick its winners and losers. Late on Thursday, Nvidia (NVDA) appeared to land in the penalty box as shares tumbled double digits after the company reported. Investors keep brutally punishing companies that fail to meet expectations, and shares of NVDA—which entered earnings day down more than 30% since Oct. 1—became the latest victim. By early Friday, its shares were off more than 17% in pre-market trading.
NVDA beat expectations on earnings per share with a $1.97 figure, easily surpassing the third-party consensus of $1.71. However, that’s where the positive news ended. Revenue of $3.18 billion fell short of the $3.25 billion consensus expectation, and guidance for fiscal Q4 revenue of $2.7 billion didn’t come close to hitting Wall Street analysts’ projections of $3.4 billion. This kind of guidance might call into question the health of the semiconductor and consumer electronics sector as a whole. Shares of Advanced Micro Devices (AMD) and Intel (INTC) also got hit in pre-market trading, with AMD recently down 6%.
It’s particularly concerning to see NVDA’s biggest business, for gaming chips, fall short in its latest quarter. That might speak to some demand issues as we head into the holiday shopping season, when video games are often a popular item. Time will tell, but it’s definitely something to check back on after Black Friday next week to see if there’s a read on gaming sales.
The way home builder stocks got huffed and puffed around Thursday, you might have thought they were made of straw. The weakness stemmed partially from KB Homes’ (KBH) weaker than expected guidance. KBH shares plunged more than 15%, and selling spread across the sector and to stocks like Home Depot (HD) and Lowe’s (LOW), which derive much of their business from home building and renovating activity.
The guidance from KB for revenue of between $800 million and $860 million for Q1 of 2019 compared with nearly $900 million expected by analysts. That outlook was soft—there’s no other way to describe it, and looked bad for the entire industry. This is one where everyone took the heat, and home builders including D.R. Horton (DHI) and LGI Homes (LGIH) also got pushed lower, though not to the same extent as KB.
Higher mortgage rates are a big part of the story, it seems. It also appears that despite strong job growth, many people might not feel comfortable making big long-term purchases even while they’re snapping up smaller items to fill shorter-term needs (retail sales rose more than expected in October, for instance). The picture for the home market looks pretty deflated, and things may stay this way for the next six to nine months until there’s some stabilization in interest rates and home prices. At that point, housing might improve, but perhaps at lower price levels.
Also, some analysts looked at HD’s strong outlook earlier this week and said HD’s projections for next year may be better, but that some of that might reflect one-time shoppers dealing with hurricane damage. It might not be something you can depend on every year, and that school of thought could be tempering expectations for the company.
Stocks enter Friday still down nearly 2% for the week, but off their lows after Thursday’s late recovery.
The S&P 500 Index (SPX) managed a 2730 close Thursday after falling below 2700 at times earlier this week, and it seems to have found buying interest down under that psychological round number. Some of the more beaten-down sectors, including info tech, energy, and materials, helped lead the charge back, but it’s been more than a week since the market posted consecutive positive sessions. Today might be a test, and that 2700 level could once again be a support point to consider watching.
The more positive tone Thursday probably reflected a little bargain basement shopping as Apple (AAPL) shares, in particular, picked up the pace after landing in a bear market earlier this week. News of Warren Buffett buying more shares might have lent support to the battered name. He also bought shares of JP Morgan (JPM), which rallied Thursday as well. Still, that’s quickly becoming old news, so it’s questionable whether it can continue to support those stocks today.
That said, when AAPL took off Thursday, it seemed to pull some other FAANG stocks out of their funk, and that might have helped lift general sentiment around the market. These are momentum stocks, and they can inject a big charge into the broader market whenever they move significantly.
While Thursday’s action took a more bullish turn, the SPX is still well below last week’s 2781 close, so it would take a monster rally to give the week a green tint. Volatility continues to hold near recent highs, but the VIX came down to just below 20 by late Thursday after topping 22 earlier this week. By early Friday it was back above 20.
Figure 1: Back to Earth For Natural Gas: One day after a double-digit gain, natural gas futures (candlestick) got slammed with a nearly 20% dive Thursday. Some retracing of gains due to overbought conditions might have played a part, along with a large weekly supply build. It was the worst daily performance for the commodity in 15 years. Meanwhile, crude oil (purple line), which fell into a bear market earlier this week, continues to inch back a bit despite a big weekly rise in U.S. stockpiles. Data Source: CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Hike Odds Ease: After Wednesday’s remarks from Fed Chair Jerome Powell when he expressed worries about slowing economies abroad, chances of a Fed rate hike started to fall. The odds of a December hike, are now around 72%, according to Fed funds futures, down from 76% earlier this week. The odds of 2019 action also seem to be getting pushed back. March rate hike odds once stood at 50-50. Now they’re around 40%. Chances of a hike don’t reach 50% until the June Fed meeting, meaning many investors think the Fed might go through nearly the entire first half of the year with no further rate hikes after December. There’s also only an 8% chance of the key rate rising above 3% by next September, despite the last Fed “dot plot” showing many Fed officials expecting that level by then. A new “dot plot” is due next month, but for now it looks like the market expects the Fed to be less hawkish. Many investors appear to believe that the Fed is getting a bit wary amid slowing economic growth abroad and rather vanilla U.S. inflation numbers.
Across the Pond: If Powell is worried about overseas economies, maybe it’s because he caught a glimpse of recent data from Europe. Germany (the largest economy on the continent), saw its gross domestic product (GDP) fall 0.2% in Q2, the first contraction there since 2015. As a whole, the eurozone economy did a little better, growing 0.2% between July and September. Brexit worries, political static in Germany, and Italian budget issues might be playing into the weak growth across the continent, analysts said. Those issues started in Europe, but also could affect the U.S. thanks to many U.S. companies having exposure to the European economy. The European Union is the largest U.S. trading partner, taking in $283 billion in U.S. exports last year.
The rising dollar—which is also reacting to European turmoil—could threaten some of those sales. To get a sense of which U.S. industries might suffer if European demand falls, consider that the top U.S. exports to Europe in 2016 were aircraft ($38.5 billion), machinery ($29.4 billion), pharmaceutical products ($26.4 billion), optic and medical Instruments ($25.6 billion), and electrical machinery ($20.8 billion), according to the Office of the U.S. Trade Representative.
Wrapping Up Earnings: This week’s batch of retail earnings marks the end of another reporting season, and it was a pretty impressive one. With more than 90% of S&P 500 company results in the books, earnings rose 28.3% from a year ago, according to S&P Capital IQ. That compared with pre-earnings average analyst estimates for about 21% growth. About 78% of companies beat analysts’ earnings estimates, and 59% beat on revenue, according to research firm CFRA, both above historic averages. Earnings continue to benefit from strong U.S. consumer demand, last year’s tax cut, and buy-backs.
The concern is what’s next. This year’s string of huge quarters could be a tough comparison come 2019, and many companies have guided on the conservative side as they assess threats ranging from tariffs to slowing overseas economies to the strong dollar and higher cost of goods. Another thing to consider is the cost of hiring, as many companies have hiked their minimum wages and the Labor Department showed hourly pay rising more than 3% in October. One thing worth remembering, however, is that at a forward price-to-earnings ratio of 15.9, according to CFRA, the market might have already priced in slower earnings growth for next year. Also, company sales growth has been better than analysts had expected, which might help margins even as companies struggle with other barriers to profit.
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