Ricochet Wednesday: Rebound Seen Possible But Trade Fears Still Linger

The market appears to be ready for a possible rebound early Wednesday, but fears of a possible trade war haven’t vanished.

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(Wednesday Market Open) After several days of tumbling amid trade war fears, markets look like they’re ready to possibly rebound a little Wednesday. Strength in European and Asian indices overnight could help provide some traction, and a slight pullback in bond prices might indicate more willingness among investors to embrace risk.

At the same time, volatility faded a bit, with the Cboe VIX falling back below 13 after rising above 14 earlier this week.

Despite these positive developments and a rally in pre-market trading, there’s no major change on the trade front that’s helped pin down stocks over the last few days. Maybe after a six-day losing streak for the Dow Jones Industrial Average ($DJI), people are simply engaged in some bargain hunting. Whether this can give the market a lift that lasts is unclear. We shall see.

In a major development right before the opening bell, media outlets reported that Disney (DIS) had raised its bid for 21st Century Fox (FOXA) assets to $71.3 billion in cash and stock. The new bid rivals Comcast's (CMCSA)  $35 a share all-cash bid last week, in a deal that would be valued at $65 billion, CNBC reported. In a statement, Fox called the new Disney offer "superior" to the Comcast proposal made last week. 

Learning From the Past

One way to put this week’s gloomy market into perspective is to take a historic view and not focus on point losses in the major indices. Yes, the DJIA was down more than 300 points much of the day Tuesday, and is now negative for the year. However, the DJIA entered the week trading above 25,000, so a 300-point drop isn’t necessarily as perilous as it might sound. It’s just a little over 1%. 

Some old-timers might remember the DJIA’s gut-churning Black Monday drop in 1987. It fell more than 500 points that day, a 22% plunge. Today, a 500-point decline would be about 2% of the DJIA’s value.

Staying on the subject of the DJIA, Tuesday marked a bitter moment for one long-time DJIA component, General Electric (GE). After being continuously a part of the DJIA since November 1907 (it briefly was included in the DJIA as early as 1896), GE got booted out (pardon the pun) by Walgreens Boots Alliance (WBA). This follows a 55% loss in GE shares over the last year.

Earnings Potpourri

In earnings news after the close, Oracle (ORCL) beat Wall Street analysts’ estimates, but the stock fell in post-market trading in what appeared to be reaction to the company’s guidance. As we saw during the recent earnings season, increasingly investors don’t want to hear what a company did in the past, but what it might do in the future, and ORCL faces a lot of competition in the cloud space. FedEx (FDX) also beat Wall Street’s quarterly projections but shares fell as investors digested what appeared to be a disappointing outlook amid lower margins.

This afternoon, Micron (MU) is expected to report. 

In other corporate news, you might have to walk a little farther for your favorite cup of “joe.” Starbucks (SBUX) said it plans to close 150 U.S. stores due to increased competition. Shares fell 4% in pre-market trading as some analysts cut their price targets after the announcement. The company’s same-store growth estimate of 1% also seemed to disappoint some investors, as it was below the Street’s estimates.

Tuesday saw the third consecutive session of trade war fears looming over the market. Once again, some of the so-called “cyclical” sectors like industrials, technology, and materials that could potentially suffer more in a possible trade war were outpaced by more “defensive” sectors including healthcare, consumer staples, telecom, and utilities. 

In another sign of more investors embracing “safer” investments, Treasury prices rose again Tuesday, sending yields lower and cutting the gap between the 2-year and 10-year Treasury yields to its lowest level in about a decade at 34 points. This sort of action tends to be bearish for financials, because lenders make money on net interest margin (NIM) — the difference between what they charge for loans and what they pay on deposits. The benchmark 10-year yield finished the day just below 2.9%, a bit below recent highs, and the financial sector found itself in the red again. However, Treasuries moved lower early Wednesday and the yield rose back above 2.9%.

Info tech, which had drawn some buying interest in recent days amid thoughts that the sector might not be as badly impacted by trade battles, couldn’t keep its head above water Tuesday. Chipmaker stocks fell hard as tariff fears reared. Apple (AAPL) also fell, although CNBC reported that the U.S. administration told Apple leaders that China had said iPods (which are made in China) wouldn’t be subject to Chinese tariffs. The very fact that the subject was being discussed at all might have caused some concern for AAPL investors.

DJIA Now in the Red for 2018

It wasn’t all doom and gloom Tuesday. First, the S&P 500 (SPX) and Nasdaq (COMP) continued to outperform the DJIA and remain higher for the year. The DJIA is now below its 2017 close as pressure on multinationals like Boeing (BA) and Caterpillar (CAT) keeps it pinned down, but the COMP is up nearly 12% and the SPX is up more than 3%. The small-cap Russell 2000 (RUT) posted small gains Tuesday and remains up double-digits for the year. Some investors see small-caps having less exposure to trade battles, since small companies tend to rely more on domestic sales.

Also, it was another day where markets opened with steep losses and then spent much of the session clawing back. This seems to be a pattern recently, and might be a sign that early panic-related selling doesn’t necessarily have the power to cause a major market wash-out. Not that anyone can guarantee that, of course, but the market’s ability to rebound each of the last three days does suggest buying interest at the lows. This could be a reflection that beneath the trade concerns, many investors remain aware of the bright U.S. economic picture. Housing data early in the day was mixed, looking positive for May housing starts but a little less so for building permits.

Figure 1:  Left Behind: After more than 100 years as part of the Dow Jones Industrial Average ($DJI), General Electric (GE) got replaced Tuesday by Walgreens Boots Alliance (WBA). This chart shows how GE shares (candlestick) got outpaced by the $DJI (purple line) over the last two years. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD AmeritradeFor illustrative purposes only. Past performance does not guarantee future results.

Crude in Holding Pattern Ahead of OPEC: The crude oil market seems to be pivoting around the mid-$60s, and that could be the case for a little while, as investors await Friday’s key OPEC meeting. There’s widespread belief among analysts that some sort of production hike might happen, but how much is anyone’s guess. Some talk on the Street early this week centered on a potential 500,000 barrel-a-day production rise, but whether that would be enough to make up for potential supply losses from Iran and Venezuela is anyone’s guess. Crude oil is down about 8% from its highs last month, and transport stocks might be among the first to reflect any possible new infusion of oil into the market. The Dow Jones Transportation Average ($DJT) is up a touch over the last month and might get another boost if OPEC decides to loosen the spigots.

Watch For the Curve: The dive some investors are taking back into the “three horsemen of risk”—Treasuries, gold, and the CBOE Volatility index, or VIX—seems to be one of the factors helping push the yield curve lower, with possible ramifications for the economy. The curve, or the gap between 2-year and 10-year Treasury yields—fell to 34 points Tuesday, down from above 70 last year. A long-term chart of economic growth shows that each of the last several recessions came after the yield curve ventured into inverted territory, which is when 2-year yields rise above 10-year yields. We’re not there yet, and most economists continue to see no sign of incipient economic weakness. Also, there’s a debate about whether an inverted yield curve actually triggers recessions or if it’s something that simply accompanies recessions.

Shorter-term yields are rising vs. longer-term yields in part because some investors might see less risk posed by rising interest rates in the shorter-dated Treasuries. Several Fed speakers are on tap this week, so consider checking what they have to say about the possible future course of rates and how that might affect the bond market. For now, many investors seem inclined to seek cover, especially with short-term government Treasuries paying yields well over the average yield of the S&P 500 (SPX).

Taking the Lead: Despite this week’s stock market weakness, many signs point toward a booming U.S. economy. One good way to get a sense of exactly what’s driving that boom could be Thursday’s leading indicators report from the Conference Board. Consensus among Wall Street analysts is for a 0.4% rise in May leading indicators, the same growth as we saw in April, according to Briefing.com. If that’s the case, it would continue what’s been a seven-month string of rises in the index going back to last October. In April, eight of the 10 indicators that go into the index generated a positive contribution. However, building permits fell, and whether that was an anomaly or the start of a longer trend might be something to watch Thursday (government housing data Tuesday showed May building permits down from April on a seasonally-adjusted basis). 

Good Trading, 
JJ
@TDAJJKinahan 

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This Week’s Economic Calendar. Source: Briefing.com
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