This morning, the attention of investors is on Corporate America, with a number of important quarterly reports released after the close of trading yesterday afternoon. The headliner came from Tesla (TSLA). The electric vehicle (EV) maker posted better-than-expected earnings on an adjusted basis, but revenues fell short of expectations. The company also reported a gross profit margin level on automobiles of 27.9% (26.8% when excluding credits). Those figures were weaker than expected, owing to higher operating costs. The stock, which was down 37% year to date heading into the release, is trading lower by more than 5% in pre-market action. Conversely, shares of International Business Machines (IBM) are trading higher after the technology company beat consensus predictions on both the top and bottom lines and raised its full-year outlook. Semiconductor company Lam Research (LRCX) also beat expectations on both lines, but its stock is pointing to a modestly lower start as the company’s near-term guidance disappointed investors.
Overall, the equity futures were modestly higher this morning on the earnings news, but weakened after news broke that U.K. Prime Minister Liz Truss will be stepping down from her position after only weeks in the role. She will continue until a successor to replace her is chosen. This may add a bit of near-term uncertainty to Britain’s financial markets and cause some volatility in bonds directly backed by the U.K. government (known as “Gilts”) and also pressure the value of the British pound currency.
On the economic front, the schedule is light today. At 8:30 A.M. (EDT), the Labor Department reported that initial jobless claims for the week ending October 15th came in at 214,000, which was down 14,000 from the prior-week period and still an indicator of a tight labor market. Meanwhile, the latest reading on manufacturing activity in the greater Philadelphia area was down 8.7%. The Federal Reserve’s Beige Book, a summation of economic conditions released at 2:00 P.M. (EDT) yesterday, painted a mixed picture of the economy. While the U.S. economy continued to expand “modestly,” the pace of growth was slowing, with pockets of weakness emerging in some areas, including housing. The Fed also noted that while the U.S. job market is still very tight, the central bank’s fight to rein in inflation could cause a recession.
In particular, the housing market has been the poster child for those thinking we are headed toward a recession. The continued inversion of the Treasury yield curve is suggesting such, and the housing market is looking like it is already in a recession. The Wells Fargo/National Association of Home Builders’ Sentiment Index fell to 38, which was the 10th consecutive decline and a clear indication that housing market conditions are eroding. That report was followed by yesterday’s disappointing release on September new residential construction. The report showed housing starts, which are a forward-looking indicator of construction activity, fell to an annualized rate of 1.44 million. This was down from the prior-month figure of 1.57 million and below the consensus forecast of 1.47 million.
The higher borrowing costs faced by prospective home buyers (the rate on the average 30-year fixed mortgage recently topped 7.00%), along with a jump in housing inventory, are part of the Fed’s plan to slow demand and ultimately push home prices and construction activity lower in an attempt to tame inflation. We also learned yesterday that weekly mortgage applications fell to a 25-year low last week, suggesting that many buyers can’t afford to buy a home in the current environment. At 10:00 A.M. (EDT), we will get the latest data on existing home sales from the National Association of Realtors. Shares of the homebuilding stocks, including those of Lennar (LEN), which recently lowered its near-term financial expectations, are trading well below their 52-week highs and are unlikely to retrace much of the lost ground in the near term, given the higher lending rates and deteriorating homebuilding fundamentals – particularly the possibility of a recession.
Rising Treasury market yields, which are spiking again this week, are making it more difficult for businesses to invest in their operations and for consumers to obtain credit. There has also been a direct correlation between rising yields and weak equity market performances. It should be noted that stocks sold off on yesterday’s weak (lower prices and higher interest rates) Treasury bond auction, which put additional upward pressure on other fixed-income yields. This is not overly surprising, especially with technology stocks, as most tech companies are valued on future cash flow potential. So when rates rise, the cash flows are reduced when discounted back to present value terms, which lowers the intrinsic value of a company. Investors are less likely to pay as big a premium for an equity position in a company in a higher interest-rate environment. Intrinsic value measures the value of an investment based on its cash flows.
That said, a few sectors have recently performed better than the broader market in this rising interest-rate environment. In particular, interest in the industrial, energy, and financial groups has picked up. The financial stocks have been helped by some better-than-expected third-quarter results from the big banks, while the oil stocks traded higher after the Organization of Petroleum Producing Countries (OPEC) and its allies announced a significant planned daily cut in oil production, which is expected to reduce supplies ahead of the peak heating season and push global oil and gas prices higher. Lastly, continued strength in travel and leisure activity has given a boost to the airline industry and that was reflected in the latest quarterly results from United Airlines Holdings (UAL) and American Airlines Group (AAL). Shares of those airliners have moved higher in response. – William G. Ferguson
At the time of this article's writing, the author did not hold positions in any of the companies mentioned.
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