Knowing what is a baby and what is bathwater is paramount

Stocks were routed yesterday as weak-handed investors let loose some of their favorite mega cap techs, opting for easy Treasuries. Flash manufacturing PMI slipped into contraction zone, but overall sentiment is carried higher by services.

Get smart. To evoke that immortal phrase made popular by the 1960s TV sitcom’s lead character Maxwell Smart, “would you believe…” Well, would you believe that the markets could log their biggest single day loss since… the dark days of 2022? I hope you CAN believe it. It may be hard to remember, but stocks, even the best of them move in both directions. The stock market is not some ATM-like machine where you feed in a dollar bill and out comes a $100 bill, though many folks, even smart ones, are easily quelled into feeling that way. Don’t worry, if you are one of those, you are not alone, and, truth be told, the markets have been rather docile recently.  

Let me set the scene for you. To stage left we see an economy that keeps trudging forward powered by consumers, inflation that is clearly trending downward, and earnings that are, for the most part, healthy. To stage right we see waning consumer confidence, a wishy-washy Fed, still-restrictive monetary policy, and rising unemployment. Stage left portends smooth sailing, while stage right portends a rising probability of recession. All this on one stage can be confusing, right?

Hopefully, the lighting can add some order to the chaos (by the way, KAOS was Smart’s mortal enemy in the sitcom). Let’s see. We have a contentious Presidential election which is just starting to heat up. One contender, Trump, is a business-forward candidate who is singularly focused on boosting corporate profits, but possibly at a cost to the overall economy… and hopefully net positive for companies and their stocks. The other contender, Harris, whose policy preferences are still largely a mystery, may be more focused on tighter regulations which are costly to companies, but against profit-eating, inflation-sparking tariffs. Oh, and the race between the two is tighter than many folks on the street would believe, at this point at least. What that all means is that there is no clear path for stocks on either side and that America’s top job is up for grabs. So much for direction on that front.

That brings us back to the Fed, which seems very willing to stick to its guns and risk disaster. High lending costs are not only depleting consumers’ savings accounts, but also causing discretionary consumption to ebb. All in the name of defeating the last bit of sticky inflation. That last bit is in rents and healthcare. Both of those areas are kind of necessities with no substitutes, so even pressured consumers are inclined to maintain demand. In other words, high interest rates are not likely to deter consumers in those areas. In fact, lower interest rates would likely help bring rents down!

That’s the backdrop that traders are facing. Conflicting drivers and confusing signals. That makes for some weak hands. So, when an electric car manufacturer with a forward PE multiple of 92x compared to the 6.9x median of its peers misses its EPS estimates by -13%, it gets even the staunchest investors a bit nervous. When the CEO of the company tells investors that robots and self-driving taxis are the future (neither of which are available today), investors get yet more anxious. So, they sell. A selloff in one of the Magnificent 7 prompts a fresh wave of selling in the other 6… because all of the stuff I mentioned earlier. In fairness, Alphabet, though its report was really good, fell on slightly less than expected ad revenue from its YouTube offering. I can’t tell you if that slight miss was worth the -5% decline it suffered, but it is not likely to have fallen that much on any other day given the miss. NVIDIA, another member of the Magnificent 7 is set to announce its earnings in just over a month from now, but it suffered along with its mates yesterday giving up some -6%. Wait, did I miss something, is AI no longer the game changer we all hoped it was? Is NVIDIA no longer a leader in that just-starting-to-bloom industry?

I will leave it up to you to decide. But I can tell you this. Now is the time to sharpen your pencil. For some of your holdings, this could be a warning, but for others, this latest move can be an opportunity. Check the numbers first. Have they changed? For better or worse? Now check your thesis. Does the reason for buying and holding your stock persist? Now is the time to make sure you don’t throw the baby out with bathwater. Now is the time to remember that you are a long-term focused investor. Now is the time to be patient. Now is the time to… GET SMART.

YESTERDAY’S MARKETS

NEXT UP

• Annualized Quarterly GDP (Q2) may have picked up to +2.0% from last quarter’s +1.4%.
• Initial Jobless Claims (July 20) is expected to come in at 238k, slightly lower than last week’s 243k claims.
• Durable Goods Orders (June) probably grew by +0.3% after increasing by +0.1% in May.
• EARNINGS. This morning, Honeywell, PG&E, TransUnion, Valero, Royal Caribbean, Hasbro, Southwest Airlines, Northrop Grumman, Harley-Davidson, and AbbVie all beat on EPS and Revenues, while Dow Inc, Xerox, Carrier Global, Tractor Supply, CBRE, American Airlines, New York Community Bank, and Union Pacific missed. After the closing bell, we will hear from Weyerhaeuser, Digital Realty Trust, L3 Harris, Sketchers, Deckers Outdoors, Juniper Networks, and Norfolk Southern.