Opening Market Update

Indexes Sink As Geopolitical Concerns Hit Chips

July 17, 2024 Joe Mazzola
Discussion of possible export restrictions from the Biden administration, along with comments on Taiwan from Trump, may have helped clip markets early.

Published as of: July 17, 2024, 9:15 a.m. ET

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(Wednesday market open) Wall Street finds itself in unfamiliar territory early Wednesday, down sharply amid geopolitical concerns following yesterday's record highs.

Major indexes fell more than 1% in pre-market action, clipped by talk from the Biden administration about possible export restrictions on China and by former President Trump about Taiwan. Semiconductor shares retreated on the comments from those two rivals, with Nvidia (NVDA) and Taiwan Semiconductor (TSM) each dropping 4%. Chip equipment maker ASML (ASML) plunged nearly 8% despite a strong earnings report.

Trump, now the Republican nominee, said Taiwan should pay the U.S. for defense, in an interview with Bloomberg Businessweek published on Tuesday. Taiwan is the epicenter of global chip production, and China has long vowed to "reunify" with Taiwan, which the United States supplies with weapons.

And the Biden administration may use a stringent export control measure called the Foreign Direct Product Rule to keep China from getting the highest-level chip-making tools, Bloomberg reported. If this happened, ASML would be directly in the spotlight as a major supplier of chip equipment to China. Trump's comments on Taiwan highlighted delicate relations between China and the United States, as well as the chip industry's dependence on TSM.

"The elections remain a key risk as both candidates battle it out for who can be the toughest on China ahead of the election," said Jeffrey Kleintop, chief global investment strategist at Schwab. "Geopolitics, not growth, may now be driving AI highflyers."

Today's early weakness came after Tuesday's rally that lifted the Dow Jones Industrial Average® ($DJI) more than 700 points amid general enthusiasm about cyclical sectors like industrials and materials that tend to perform best in a growing economy. Hopes for Fed rate cuts starting in September triggered a major rotation toward those sectors starting late last week, and small caps also skyrocketed. Futures trading today suggests more small-cap strength ahead even as tech continues its retreat.

This afternoon features earnings from one of the companies that benefitted from the recent trend away from tech and into more traditional sectors. United Airlines (UAL) taxis in after the close after a sharp rally yesterday.

Other things to watch today, besides any further fall-out from geopolitics, include a couple of Federal Reserve speakers and a 20-year Treasury bond auction.

Futures based on the S&P 500® index (SPX) dropped 1% shortly before the close of overnight trading, and the Nasdaq-100® (NDX) fell 1.5%. Futures based on the $DJI were down 0.3%. 

Read all our market commentary on our Insights & Education page, and you can follow us at @SchwabResearch.  

Read all our market commentary on our Insights & Education page, and you can follow us at @SchwabResearch.  

Morning rush

  • The 10-year U.S. Treasury yield (TNX) rose two basis points to nearly 4.19%.
  • The U.S. Dollar Index ($DXY) slipped to 103.72, a four-month low, as rate cut hopes swirled.
  • The Cboe Volatility Index® (VIX) jumped to 13.99, the highest in six weeks, amid geopolitical worries.
  • WTI Crude Oil (/CL) edged 1% higher on a drop in U.S. stockpiles. 
  • Bitcoin (BTC) slipped 0.3% to $64,793.

Just in

Housing starts and building permits for June both topped analysts' expectations at a seasonally adjusted annual rate of 1.353 million and 1.446 million, respectively.

Consensus for starts was a seasonally adjusted annual rate of 1.31 million, according to Briefing.com. Permits were seen at 1.391 million. Homebuilder stocks have been on a tear the last week on hopes that falling interest rates might mean lower mortgages and get more people wanting to buy new homes.

Industrial production for June also arrives this morning just before the open. Analysts expect a 0.3% gain, down from May's 0.9% increase, Briefing.com said. The month-over-month readings have been very choppy for more than a year, but manufacturing growth in May was encouraging.

What to watch

Tomorrow's weekly initial and continuing jobless claims data has the potential to move markets if it regains momentum after slightly easing off last week. Slowing labor market conditions are likely a key factor shaping the Fed's rate decisions. The market increasingly builds in odds of as many as three Fed rate cuts by the end of the year, according to the CME FedWatch Tool.

"Downside surprises will soon likely be driven by labor, not inflation," said Kevin Gordon, senior investment strategist at Schwab. "So far, labor has softened at a non-recessionary pace, and if that continues to be the case moving forward, it’s positive for the market."

Approaching tomorrow’s data, analysts expect initial claims of 225,000, up from 222,000 the prior week, Briefing.com said. Continuing claims are seen at 1.855 million, according to Trading Economics, up just slightly from a week earlier but still near recent highs.

Leading indicators from the Conference Board for June are another report due out tomorrow morning, and have been lower almost constantly over the last year and a half. Analysts expect another decline.

Looking back at June retail sales out yesterday, the overall flat reading was in line with expectations, but the control group used to calculate gross domestic product (GDP) rose 0.9%, indicating very solid growth and well above 0.2% expectations. The Atlanta Fed GDPNow calculator rose to 2.5% for the second quarter following the retail sales data. 

Stocks in spotlight

Pharmaceutical giant Johnson & Johnson (JNJ) beat Wall Street's earnings expectations thanks in part to solid drug sales, especially for cancer and psoriasis. However, shares didn't get much of a lift, possibly owing to the company trimming its 2024 earnings per share forecast related to costs from mergers and acquisitions. However, it reiterated previous sales guidance.

Health care is among the sectors benefiting from the "rotation trade" over the last week, with the sector up more than 3%. Abbott Labs (ABT) is the next major health firm due to report, opening its books early tomorrow.

Meanwhile, ASML's earnings beat analysts' estimates, as did its revenue. However, it guided for below-consensus revenue in the third quarter even as it reaffirmed full-year revenue guidance. The company's financial results are closely monitored as a barometer of chip industry health.

Stocks on the move:

  • Five Below (FIVE) plunged 15% early Wednesday and hurt shares of other discount retailers as well on news of its CEO leaving and the company cutting earnings guidance. The company previously said high interest rates and inflation hurt its "core lower income customers."
  • Qualcomm (QCOM) dropped more than 4% in pre-market trading following a downgrade from HSBC to hold from buy.
  • US Bancorp (USB) climbed 1.6% in pre-market trading after the company's latest quarterly earnings came in ahead of analysts' expectations, boosted by strong net-interest income. That statistic measures the money banks make lending minus what they pay to customers.

Tuesday in review: Investors kept piling into the industrial and consumer stocks they'd ignored most of the year in favor of tech, lifting major indexes to record highs Tuesday as the $DJI posted its largest daily increase in a year.

"The 'great rotation' trade, which kicked off last Thursday, appears to still have legs," said Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research.

Boeing and Caterpillar were among Tuesday’s leaders, with gains of more than 3% and 4%, respectively. Honeywell climbed more than 1%. McDonald’s (MCD) and Coca-Cola (KO) also sizzled.

Meanwhile, info tech names that were hot in the first half of 2024, like Nvidia (NVDA) and Super Micro Computer (SMCI), got sold Tuesday.

Eye on the Fed

Early today, futures traders build in less than 5% chances that the benchmark funds rate will fall 25 basis points at the Federal Open Market Committee's (FOMC) July 30–31 meeting, based on the CME FedWatch Tool. Chances of a rate cut by September are around 98%.

Thinking cap

Ideas to mull as you trade or invest

Out of a "rut": Recent small-cap strength could reflect more optimism about the U.S. economy because their sales often have less international exposure compared with larger companies. Lower borrowing costs also typically help smaller firms that rely more on debt. The RUT rose more than 3% Tuesday and is up over 10% from a week ago. The RUT is now at its highest levels since early 2022, though still below its all-time high posted in late 2021.

Deal time: The "M&A Monday" trend reappeared this week. That's the market term referring to when a major media outlet like The Wall Street Journal reports a major acquisition over the weekend, setting things up for an interesting kick-off to the trading week. This time it was Alphabet (GOOGL) in the spotlight with its potential purchase of cybersecurity firm Wiz. Then steel-maker Cleveland-Cliffs (CLF) upped the ante early Monday by announcing it's acquiring Canadian steelmaker Stelco. While both of those acquisitions reflected underlying industry fundamentals, it also could be a sign that money is loosening up a bit as borrowing costs come down. Goldman Sachs (GS) earnings yesterday were another possible sign of that, with a double-digit rise in debt underwriting revenue. This follows a slow second quarter for mergers and acquisitions that saw U.S. M&A volume fall 3% to $324.4 billion, Reuters reported. Deal volume in Europe, however, jumped 27%.

FAANG in focus: One of the members of the popular "FAANG" group from last decade, Netflix (NFLX), reports earnings tomorrow after shares recently approached all-time highs from late 2021. The stock fell back from that level just above $700 over the last week or two but is up sharply this year and recently received price target increases from several analysts. They cited strong content offerings, Barron's noted in a recent article, as well as price increases from competitors that could give Netflix more flexibility to raise its prices. The second season of "Squid Game" and the broadcast of two NFL football games on Christmas Day could be catalysts for future growth, analysts said. The FAANG group might no longer be the force it once was, having been replaced by the "Magnificent Seven" that excludes Netflix. Still, Netflix earnings often remain influential on Wall Street, so don't discount the chance that a hit or miss from the streaming giant could move markets.

Calendar

July 18: June leading indicators, and expected earnings from Abbott (ABT), D.R. Horton (DHI), Domino's Pizza (DPZ), Marsh & McLennan (MMC), Taiwan Semiconductor (TSM), and Netflix (NFLX).

July 19: Expected earnings from American Express (AXP), Halliburton (HAL), Regions Financial (RF), and Travelers (TRV).

July 22: Expected earnings from Verizon (VZ).

July 23: June existing home sales and expected earnings from Coca-Cola (KO), General Motors (GM), Kimberly-Clark (KMB), Lockheed Martin (LMT), Microsoft (MSFT), Archer Daniels Midland (ADM), Philip Morris (PM), UPS (UPS), Alphabet (GOOGL), Tesla (TSLA), Texas Instruments (TXN), Visa (V).

July 24: June new home sales and expected earnings from AT&T (T), CME Group (CME), General Dynamics (GD), Chipotle (CMG), Ford Motor (F), IBM (IBM), and Waste Management (WM).

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