Fresh Thoughts From Fed Awaited After Market’s Worst Day In Weeks

 | Aug 18, 2021 10:04AM ET

“Buy the dip” is facing its toughest test in a month.

If you think back to mid-July, the major indices tanked as concerns about the Delta variant and Fed tapering ramped up. The same factors helped set off the market’s worst drop in four weeks Tuesday, and it will keep investors on their toes again today as they await Fed minutes for any insight into a possible stimulus taper. The question is whether people will step in again to buy at lower levels.

That’s what helped the market recover from mid-July jitters to August record highs, and it seemed to be in place Monday and Tuesday, when the market recovered from early weakness both times. Still, a lot weighs against people who want to buy here. You’ve got to go against the grain, so to speak, because a bunch of factors—yields, gold, volatility—are flashing yellow lights.

h2 Discretionary Stocks May Deserve An Apology/h2

Data’s another yellow light flashing, with a lot of focus first on last week’s soft consumer sentiment followed by some disappointment over Home Depot (NYSE:HD) yesterday and, of course, a drop in July retail sales.

The damage done yesterday to HD and other consumer discretionary stocks, however, might be getting overdone. That means the sector could have a decent chance to come back a bit, if and when people think through the bigger macro picture. A lot of the weakness in Tuesday’s retail sales report reflected the automobile sector, so you need to look at the number with autos taken out of the equation to get the full picture. Car companies have problems of their own right now with supply thanks to the chip shortage.

Also, just because people didn’t spend as much at stores, according to the report, doesn’t mean they’re not spending. They just could be spending on different things. It’s August and people are anxious to be on vacation, Delta variant or no Delta variant. The national parks were so crowded this summer that some of them had to turn people away. Also, bar and restaurant sales looked stronger in July than the previous month, according to yesterday’s data.

Basically, people got off track from that one number yesterday (retail sales), and even the HD numbers weren’t necessarily as bad as people made them out to be. Assuming for a moment that HD isn’t seeing demand, that doesn’t mean some of the other consumer discretionary companies, say, for instance, McDonald’s (NYSE:MCD), aren’t. E-commerce has struggled a bit, and that affected Walmart (NYSE:WMT), but a lot of that is a reflection of people wanting to get back outside. If they’re at Yosemite, let’s say, they’re probably not at WMT that day.

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The other thing to keep in mind about e-commerce in general is that comparisons are very tough versus a year ago when it was just about the only game in town, so to speak. Some stores were open by this time last year, but on a limited basis. Now the online stores have to compete again with brick and mortar. One question is how mask mandates coming back in some cities like Chicago might affect that.

h2 From Afghanistan To Suburban Driveways/h2

We’ve kind of gotten away from the other big story dominating newspapers and TV early this week: Afghanistan. It’s a terrible situation for the U.S. troops, allies and many other people who are still there, but as far as the markets go, we’ll have to wait and see on the longer-term implications. The market had a lot to grapple with Tuesday and foreign affairs didn’t appear to be a major factor.

It’s often said that Afghanistan is a place where powerful countries get hurt again and again. That may be true, but it doesn’t necessarily follow that it has a market impact. The region isn’t all that important economically, and the population of Afghanistan is about the size of Canada’s and not a major importer. Obviously, that’s not to discount the tragic circumstances going on.

Back on the home front, pun intended, home-builder stocks took it on the chin yesterday after a soft reading on home builder sentiment. Stocks like Lennar (NYSE:LEN), Toll Brothers (NYSE:TOL), KB Home (NYSE:KBH) and D.R. Horton (SA:D1HI34) played defense.

It hasn’t been a great summer for the sector as high materials costs squeezed margins and high home prices appeared to hurt consumer demand for new homes. However, some things may remain in the sector’s favor, including historically low mortgage rates and the huge recent drop in the price of lumber. Though lower-income home buyers may be facing affordability troubles, the home-builders who cater to higher-end customers may not feel the heat as much. There are still bidding wars in parts of the country.

On the other hand, it would be nice to see the first-time buyer have a better chance at getting a home of their own, something that’s gotten more and more difficult. There’s not a lot of relief from the rental market, where prices are also up. Data-wise, housing starts and building permits for July came in pretty close to expectations this morning. Starts missed consensus views, but permits were above analysts’ estimates.

h2 Small-Caps May Be Trying To Tell Us Something/h2

From a historical perspective, small-cap stocks like some of the homebuilding companies often steer the wheel for the broader market. If that’s the case now, it doesn’t look like a direction bulls will be comfortable going. The Russell 2000 index of small caps had another day yesterday where its losses were the worst of any of the major indices (see chart below).

The S&P 500, meanwhile, recovered from its heaviest losses Tuesday, so maybe a little “buy the dip” explains that. On any moves sharply to the downside from here, keep an eye on the 50-day moving average near 4341. The 50-day has been a regular bouncing point for the SPX most of this year, including the last time the market had a major hiccup in July.

That hiccup had a lot to do with the Fed, and today we get another chance to see what the central bank is thinking. Fed minutes from their July meeting are due this afternoon, and could give some insight into any possible plans on taper timing.

Volatility might spike a bit around the time those come out, with a lot of people more focused than usual on what Fed officials might have discussed and how they framed things. So be especially careful if you’re trading around that time, and consider keeping your trade sizes a bit lower than usual if you’re worried about turbulence. There’s a lot of talk that the Fed might announce a tapering schedule at its Jackson Hole symposium next week, which could explain some of the rising volatility this week.

Yesterday was a very orderly selloff, which is usually a positive sign. Still, with an orderly selloff you have to watch for follow-up selling in the next week. There may be one more day of selling to come, but not necessarily today.