Stocks closed mixed Friday. Good early earnings reports from key banks and others were offset by a mild rise in interest rates.
Earnings season rolls on this week and will be one of the dominant influences on the market. As for economic data, the key items this week will be a variety of housing numbers and a report on September retail sales. We know that housing activity has become increasingly pressured by the recent rise in 10-year Treasury yields and a coincident rise in mortgage rates. To that end, President Biden is proposing a $16 billion tax credit for qualified first-time home buyers. Note that this is a proposal, one unlikely to become law. The last thing this Congress wants, particularly the House when it gets its act together and resumes business, is another spending program with no revenue offset. As for retail sales, anecdotal evidence suggests a mixed picture. Gasoline sales will be higher based on price alone. Within the rest of the retail arena, results should be mixed. The retail sales report will most likely be the single most important economic number this week. Stocks closely related to consumer spending, except for a few high-end retailers, have been noticeably weak all year.
Tensions in the Middle East continue. Palestinians within Gaza continue to move South to avoid an imminent invasion by Israel. The invasion appears almost certain. What isn’t certain are reactions from other fronts. Iran is rattling sabers and the U.S. is sending a second aircraft carrier contingent to the region. Not being a political analyst, I will leave guessing of future repercussions to others. Economically, the biggest impact of the war is likely to be on the price of oil and on defense spending. The U.S., which supplies most of the West’s contributions to the wars in Ukraine and the Middle East, needs to fund more armament to support both efforts. While near-term, support for Ukraine and Israel isn’t at risk, the House has to be back in action in order to fund the next levels of support, whatever they may be. Again, not one to try and predict anything political, with war funding on hold and a government shutdown looming in mid-November, pressure on House Republicans to come up with some leadership solution, if only temporary, is going to keep increasing. Perhaps former Speaker McCarthy or interim Speaker McHenry can fill the gap until the Republicans can pick a permanent House Speaker. With all this said, the stock market has no conscience. It reacts to earnings and interest rates. The House turmoil has limited impact on both. Obviously, that picture could change if the fighting today rages beyond Israel’s borders. For the moment, that’s an if, and not priced into markets.
What we learned last week from earnings is how well-managed companies can cope with economic headwinds. United Healthcare# found ways to offset rising medical costs in its insurance business. JPMorgan Chase# and Wells Fargo# both found pockets of strength while changing portfolio duration that led to better than expected net interest margins. Pepsico used pricing effectively as did Delta.
Earnings season is all about two factors: how well earnings did versus expectations, and how future outlooks expressed by managements jive with investors’ expectations for the future. The actual numbers themselves, in isolation, don’t matter much. It’s how those numbers compare to the expectations already priced in.
Not all the news will be good. Pfizer# this morning sharply lowered near-term guidance because Americans are opting to take far fewer Covid vaccine shots than had been anticipated. Covid isn’t gone, but its severity has been reduced. For most who contract the disease today, the result is akin to a mild case of the flu or less. Few without co-morbidity symptoms end up in hospitals. Many believe the shots do little anyway. At any rate, the news this morning demonstrates the downside of worse than expected news. The stock prices of vaccine producers are down 2-4% in premarket trading.
Stocks rallied last week. Did they set a bottom? Is the August-September correction over? Seasonally, one could say yes. Earnings season should be supportive of a recovery. But the economy continues to slow and the geopolitical picture certainly inflates risk. The key probably lies within the bond market, particularly trends in yields on the 10-year Treasury. Few expect the Fed to raise rates at its next meeting in two weeks. For now, the 10-year yield appears to be settling in a range of 4.5-4.9%, a level consistent with a long-term expectation of modest growth and lower inflation. It would likely fall below that range should a recession loom or inflation recedes faster than expected. Conversely, it would leap higher should inflation stall in the 3.5-4.0% range for an extended period or the economy grows faster than expected. A case can be made for both sides. A middle of the road conclusion, therefore, would suggest a choppier market than is typical for a fourth quarter with interim movements closely tied to Fedspeak, inflation data, and changing trends in the pace of economic activity. A vibrant Christmas season doesn’t seem likely.
Today, Bryce Harper is 31. Go Phillies!
James M. Meyer, CFA 610-260-2220