Stock Market This Week: Five Themes to Watch

Perhaps it was a collective sense of optimism heading into the Fourth of July weekend that helped buoy the major equity indices. Whatever the primary catalyst, it was a much-needed one. Among the surprisingly strong players were homebuilders like D.R. Horton (DHI), which enjoyed significant upside as the yield on the 10-year Treasury note fell to a one-month low of 2.888%. Naturally, lower Treasury yields correspond with lower mortgage rates.

However, zooming out to a wider aspect ratio, the situation for stocks still does not look encouraging. On a year-to-date basis, the benchmark S&P 500 is down slightly over 20%, straddling the unofficial threshold of a bear market correction. During the same period, the technology-centric Nasdaq index is down nearly 30%, clearly reflecting broader risk-off sentiment. Despite Friday’s positive session, when the dust settled on June 30, Wall Street was staring at its worst first-half performance since 1970.

On one level, some investors may interpret the downturn as a tremendous buying opportunity. For instance, companies like PayPal (PYPL) which are fundamentally relevant to contemporary business trends such as the gig economy are down significantly, in PYPL’s case hemorrhaging over 63% YTD.

But on the other end of the spectrum, the market could be unwinding years of easy money policies that have artificially inflated equity valuations. If so, the red ink in the charts could be just the beginning. Below are some of the key factors to consider for the upcoming week.

Turbulent Start to Independence Day

With millions of Corporate America’s office warriors essentially barred from their vacation plans for roughly two years due to the COVID-19 pandemic, pent-up demand – colloquially known as revenge travel – is a tangible phenomenon. Therefore, it was no surprise that the Fourth of July weekend would feature massive crowds at airports.

However, prior to the festivities, many analysts were anxiously eyeballing travel industry dynamics. Thanks to staff shortages – particularly pilots – along with inclement weather, fears rose about delays, cancellations and other disruptions. So far, the early indications are not promising.

Reports on Friday came out that airliners canceled nearly 600 flights, with more than 7,600 others arriving late. Some of the biggest contributors to the delays included American Airlines (AAL) and Delta (DAL).

Economically, perhaps the biggest concern that investors should watch out for is the potentially detrimental effect of word of mouth. As consumers hear nightmare stories one after the other, many households may decide to close their wallets and wait for friendlier skies. If so, airliners could find themselves in a very tricky situation.

Russia Sends a Message to the West

During the week when world leaders representing the Group of Seven (G-7) met in Germany, Russia unleashed a torrent of attacks against neighboring Ukraine, escalating an already bloody military conflict. First, Russian forces attacked Ukraine’s capital city Kyiv, then later, fired missiles at a crowded shopping mall in Kremenchuk.

According to military experts, the attacks served as a message to western powers. Per retired Lt. Gen. Ben Hodges, the former commanding general of U.S. Army forces in Europe, “The Russians are humiliating the leaders of the West.”

Although President Joe Biden has repeatedly stated that he would not put American boots on the ground in Ukraine, at some point in the future, both the U.S. and its allies will need to reassess its Russia policy. Unfortunately, the reality of the matter is that so long as a military crisis exists in Europe proper, the stability of the global economy is under threat.

Brewing Troubles in the Far East

As if the Biden administration didn’t have enough on its plate, Russia’s escalation of its “special military operation” in Ukraine and western nations’ general reluctance to truly provide Ukrainian forces with robust firepower draws questions about China and its intentions regarding Taiwan.

According to The Economist, Taiwan Semiconductor (TSM) “controls 90% of the market for the most advanced kind of chips—those with components smaller than ten nanometres.” Therefore, it’s not just the U.S. that sees a possible invasion of Taiwan as a threat to its national security but other regional powers like Japan.

Alarmingly, the Associated Press recently reported that Russia issued a decree that a new company will take over ownership of Sakhalin Energy Investment Co., which is partially controlled by Japanese energy firms. The Sakhalin-2 project is one of the world’s largest export-oriented oil and natural gas projects and provides critical energy outflows to the Asian market.

Broadly, the concern is that unless western forces impose substantial and painful consequences to belligerent state actors, the modern global order could devolve into a might-makes-right policy.

Michael Burry Makes Noise

Hedge fund manager Michael Burry – whose audacious bet against the housing market prior to the Great Recession was chronicled in the movie “The Big Short” – has been making noise on social media over the past several days. Arguably one of the most important tweets he issued was regarding the bullwhip effect.

Essentially the business consequence when retailers overstate future demand, leading to unnecessarily excessive procurement of inventory, Burry warned that the bullwhip effect could lead to retailers taking drastic actions to unwind their mistake. Namely, this would involve giving refund-seeking customers their money back – along with the product they initially bought free of charge.

Of course, such a tactic would have fiscal consequences, likely sparking mass layoffs. In turn, the economy could slow worryingly, resulting in the Federal Reserve reversing its hawkish monetary policy.

While Burry might sound like a Chicken Little, the reality is that companies like Amazon (AMZN), Walmart (WMT) and Target (TGT) have been paying customers to keep their returns since at least late last year. Therefore, the alarm bells might not be unjustified.

Earnings in Focus

Because of the holiday-shortened week, investors don’t have too many noteworthy earnings reports to watch. However, on Wednesday, Saratoga Investment (SAR), which provides debt financing and equity capital to middle market companies may provide important insights into business sentiment. Covering analysts expect Saratoga to deliver earnings per share of 55 cents.

On Thursday, Levi Strauss & Co. (LEVI) will release its quarterly financial disclosure. Covering analysts are looking for the apparel giant to deliver EPS of 23 cents. For retail investors, Levi Strauss can provide important clues regarding consumer sentiment for luxury items.

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