Risk on seems to remain as the market continues to move higher after strong Best Buy results

Risk on seems to remain as the market continues to move higher after strong Best Buy results

Getty Images

Getty Images

The central theses:

  • Best Buy BBY to be new retailer with better profits than Wall Street analysts expect
  • New home sales are imminent after strong data on existing home sales was released on Monday
  • Conviction a little hard to find in low volume trading prior to the Fed’s Jackson Hole event

What can Wall Street do for an encore after another big rally earlier in the week?

Maybe not much, at least for now. Shares rose just a little in the pre-trading session. Early on, it looks like there may be a chance for small gains on top of what happened yesterday, but the lack of major new developments could keep things simmering.

However, the “risk taking” vibe we saw yesterday doesn’t seem to be easing as government bond and crude oil yields rose early after a strong Tuesday in Asian markets.

The calendar is not completely empty today. The new home sales are due at 10 a.m. ET and Best Buy (BBY) profits this morning absolutely knocked it down, putting the company’s stock at a 4% gain ahead of the opening. Basically, if you look at retail profits, this quarter has been one highlight role after another, though the clock is running out very quickly towards the end of the contest.

As BBY noted in its press release, the company has overcome last year’s weird blackout, when customers were mostly limited to roadside service and in-store appointments roughly half the time. However, the results were also strong compared to two years ago. It’s good to see companies making this comparison so you can get a feel for the performance versus pre-Covid times. BBY has also raised the comparable revenue forecast for the second half of the fiscal year, but continues to expect a decline. It didn’t seem affected by all of the recent bottlenecks.

BBY was a report that some people were nervous about, so the strong showing could be something that gave stocks a small boost, along with the strength in China. Crude oil has also risen again and it looks like it is ready to march back to $ 70 a barrel.

Could conviction stall if the Fed makes gathering looms?

With the Fed meeting up in Jackson Hole at the end of the week, the chances are the market could be running around one way or another this week in search of some sort of conviction. For a lot of people it is just very confusing where to go and what to do now because so much mixed news is getting through.

There is a lighter volume, which is understandable as summer is over. But we can also see lower volume in the last few days because it’s hard to be really convinced one way or another right now. Perhaps the Fed can show us a way forward. Still, the path of least resistance appears higher after yesterday’s solid move higher.

Speaking of higher, July existing home sales surpassed analysts’ average yesterday at a seasonally adjusted annual pace of 5.99 million, according to the National Association of Realtors. High prices and low supply continue to tell us that housing demand remains strong. However, looking a little deeper into the data there are some signs of cooling. The supply of existing properties on the market climbed to 2.6 months after 2.5 months in the previous month. And the median price rose 17.8% year-on-year, compared to 23.2% in the previous month.

Depth reading

A cautionary note still applies to the “breadth” and depth of this rally. The major indices seem to be making new highs here on a fairly regular basis. But as we noted yesterday, much of it reflects some of the “mega-caps” and their enormous weighting.

Monday provided further evidence of this. Towards the end of the session you could almost throw a pile of darts at a board with all the “mega-caps” and it would inevitably hit higher stocks. It wasn’t just the “FAANGs” either, although they all made nice profits. This also included Microsoft MSFT (MSFT), Tesla TSLA (TSLA), Nvidia NVDA (NVDA), and JP Morgan (JPM), all of which are among the most highly capitalized companies in the market.

Lately this has been happening, so to speak, without so much involvement below. Most worrisome was the weakness of the Russell 2000 Index (RUT) for small-cap stocks, which is sometimes viewed as a barometer for the rest of the market. When it starts to falter, as it did in mid-2018, it can sometimes indicate problems for everyone up front. Another sign of potential problems is if the mega-caps continue to rise but the rest of the market gives way. As one observer recently said, in addition to the generals, you also need a few soldiers.

RUT actually outperformed the broader market on Monday, but keep watching that relationship. Last year, the biggest mega-cap names could carry the torch through the summer but stalled in the fall. If they start losing ground, there may not be enough depth below them to prevent a proper retreat.

Vaccine approval offers Monday push

Right now, it doesn’t seem too many people worried about pulling out, considering how things went on Wall Street earlier in the week. News that the U.S. Food and Drug Administration (FDA) had approved Pfizer’s PFE (PFE) and BioNTech (BNTX) Covid vaccine gave the market a chance, if you will, and nine of the 12 S&P Sectors gained ground Monday. Energy received the biggest boost, along with the “reopening” of stocks, possibly on ideas that official approval could result in more companies requiring employees to get the shots.

Perhaps investors believe the official FDA approval will convince more of the reluctance to get their vaccines, causing serious cases to decline. Airlines, hotels, restaurants and casinos were some of the subsectors that got the week off to a positive start.

Cars have been another subsector to be scrutinized lately and this morning saw strong profits from Advance Auto (AAP). The company beat Wall Street’s consensus estimates for sales and earnings with comparable sales up nearly 6% year over year, while stocks were lower in pre-market trading. This is one that you get every now and then that will leave you scratching your head a little.

DAY PASS: WITHDRAW? HARDLY: Airline stocks (XAL – Candlestick) had a good day on Monday … [+] after the FDA approved Pfizer’s Covid vaccine, but they haven’t really climbed much for most of the year and are way behind the S&P 500 index (SPX – purple line). Data source: NYSE, S&P Dow Jones indices. Diagram source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Data source: NYSE, S&P Dow Jones indices. Diagram source: The thinkorswim® platform.

Valuation still historically high but solid profits dropping: It’s been a while since we talked about market valuation. You probably know it’s been historically high lately, but the average earnings growth of nearly 90% in Jan.

According to FactSet, the 12-month P / E for the S&P 500 recently dropped to around 21.1. That’s still well above the five-year average of 18.2, but slightly below the highs earlier this year. The P / E decline is actually happening as the SPX continues to climb against recent all-time highs, and the only way you can watch the index rise and P / E decline at the same time is through strong gains.

The caveat is that second quarter earnings growth was measured against one of the worst earnings quarters in history a year earlier during the first phase of Covid. Still, you can’t ignore that the net profit margin for S&P 500 companies was 13% in the second quarter, which according to FactSet was above the five-year average of 10.6%. For Q3, Q4 and 2022, analysts continue to expect solid profit increases. The latest earnings success cannot be described as a Covid escape. Companies thrive in all industries.

Mega-caps drove growth in the second quarter, but they weren’t alone: Of course, one could speak of a robust corporate health, largely reflected in an S&P 500 index (SPX), which at the close of trading on Monday was about double the Covid low of March 2020. An 18-month doubling period is unlikely to be happening again and likely reflects the quick turnaround from those early bleak predictions about what Covid could do to the economy. Even so, the SPX is still up a solid 31% from its pre-Covid peak in February 2020. This is not an easy task considering he had to climb the proverbial “wall of worry”.

The other caveat that you could throw away there is one that we have mentioned many times before. The rally was largely driven by a number of “mega-cap” stocks which, valued at trillions of dollars, hold an astonishing weight in the index. There is quite a bit to be said about that until you look at the sector view for the year to date and find that the Energy, Finance, Real Estate, and Healthcare SBRA are among the leaders. There isn’t a single $ 1 trillion company in any of these sectors.

In addition, each sector showed solid earnings growth in the second quarter. Not only Apple AAPL (AAPL), Alphabet (Demokratie), Amazon AMZN (AMZN) and Microsoft (MSFT) shone brightly and everyone else reflected their shine.

Surprise Pattern: It is interesting to see that the Friday and Monday market advance came after a recent surge in volatility. Volatility rose 20% last week, marking Instinet’s seventh high since March 2020. The market settled after each of the first six volatility spikes, Barron’s reported, and for most of the time the SPX rose higher in the weeks that followed. Again, there isn’t a rule that history has to repeat itself, but this time it seems to be happening. Volatility started to decline earlier in the week, with the Cboe Volatility Index (VIX) back below 18 after climbing above 20 a week ago. The VIX is a bit higher this morning, just over 17, but it’s probably more about people looking for possible protection ahead of Fed Chairman Jerome Powell’s speech this Friday.

TD Ameritrade® comments for educational purposes only. Member of SIPC.