Stock Market This Week: Five Themes to Watch

Despite several headwinds fundamentally weighing on both the economy and the wider equities sector, the benchmark S&P 500 enjoyed a strong outing last week, gaining over 4%. Over the trailing month, the index has swung higher 9%, paring back the year-to-date loss to just under 14%. Previously, the mainstream barometer was languishing at 20% down, a common threshold of a bear market correction.

Still, the week ahead will likely be a challenging one for investors to decipher. Primarily, the theme is geopolitics. Though Russia’s military aggression in Ukraine continues to dominate headlines, it’s also fair to point out that relations between the U.S. and China have stumbled to worrying lows since the start of the COVID-19 pandemic. Recent developments suggest that ties will worsen before they improve.

On the economic front, last week was an eventful period, highlighted by the Federal Reserve raising the benchmark interest rate by 75 basis points. Committed to attacking the inflation problem, the Fed’s strong action clearly boosted sentiment on Wall Street. However, being too aggressive can also lead to a slowdown of business activity, a circumstance that could be arguably worse than just rising prices.

Again, market participants need to brace for a slate of pertinent developments. Here are five themes to watch for the first week of August 2022.

Nancy Pelosi and the Taiwan Flashpoint

Over the weekend, House Speaker Nancy Pelosi left for Asia to visit key U.S. allies, a schedule that includes planned stops to Singapore, Malaysia, South Korea and Japan. However, what was left as an open question was whether or not Speaker Pelosi was going to visit Taiwan. Naturally, the Chinese government – which has long claimed the breakaway island as part of its territory – were upset at the potential geopolitical flashpoint.

In a call prior to the overseas trip, President Xi Jinping of China warned U.S. President Joe Biden that Pelosi’s trip risks inflaming tensions. “Resolutely safeguarding China’s national sovereignty and territorial integrity is the firm will of the more than 1.4 billion Chinese people,” foreign ministry spokesperson Zhao Lijian said Friday. “Those who play with fire will perish by it.”

Amid the backdrop of the high-level warnings is the possibility that U.S. regulators could delist public Chinese companies whose shares are traded on American exchanges unless they comply with accounting transparency requests. While China doesn’t want to lose access to U.S. capital markets, Beijing also doesn’t want to lose face on the Taiwan issue.

With each side unable back down, investors need to watch this escalating matter very closely.

Prisoner Swap Dilemma

As if international relations couldn’t be any more fraught with risk, the U.S. is embroiled in a potential – and incredibly controversial – exchange of prisoners. In securing the release of Brittney Griner and Paul Whelan who are both in Russian custody, the Biden administration has offered to release notorious arms trafficker Viktor Bout.

Griner is a professional basketball player who was caught bringing cannabis into Russia, which deems the substance illegal for both medical and recreational purposes. Whelan, according to a CNN report, is a former Marine who Russian authorities detained and later arrested on espionage charges.

On the other hand, The Washington Post describes Bout as one of the world’s most notorious arms traffickers. Indeed, the U.K. Parliament labeled Bout “the leading merchant of death” for supplying heavy weaponry to a rebel movement in Angola as well as Liberia’s Charles Taylor, then supporting a deadly civil war in neighboring Sierra Leone.

For the White House, releasing Bout presents two major problems. First, it incentivizes less-than-reputable nations of targeting U.S. citizens for ransom, thus presenting a broader security risk. Second, obtaining Bout’s freedom gives the Kremlin a critical victory, one that could provide ideological – if not outright physical – momentum for Russia’s invasion of Ukraine.

Clouds Looming Over Real Estate

Throughout 2021, the narrative that real estate experts broadcasted was that it would be better for prospective homebuyers to secure whatever residential unit they could lest prices surge even higher. Although the skyrocketing inflation rate presented a major affordability crisis for buyers, at least subterranean interest rates helped mitigate some of the pain.

However, the Federal Reserve is now pivoting to the opposite end of the monetary policy spectrum. With the world’s most powerful central bank raising the key interest rate by 75 basis points, the resultant downwind consequence will lead to higher mortgage rates, thus worsening affordability.

Today, it’s no longer a theoretical musing but a sharp reality. For instance, homebuilders are now seeing a conspicuous rise in cancellation rates as compared to the year-ago level. Moreover, in June, “roughly 60,000 home-purchase agreements fell through in June, equal to 14.9% of homes that went under contract that month,” per a press release published on Business Wire.

While it’s possible to make the argument that homebuilders are trading at attractive discounts right now, if the reason for the negative valuation adjustment is related to severe economic headwinds, investors will need to exercise extreme caution before engaging this sector.

Consumer Behavioral Shifts

Another factor to consider before acquiring stocks in companies specializing in big-ticket items (like real estate) is the shift in consumer behavior. Long story short, the rising inflation rate appears to be hitting demand, creating myriad challenges for the broader retail segment. In particular, Walmart (WMT) CEO Doug McMillon had some interesting insights to offer.

“The increasing levels of food and fuel inflation are affecting how customers spend, and while we've made good progress clearing hardline categories, apparel in Walmart U.S. is requiring more markdown dollars. We're now anticipating more pressure on general merchandise in the back half; however, we're encouraged by the start we're seeing on school supplies.”

Put another way, if the American consumer needs to make the acquisition – for example, education-related spending – they’ll do so. However, purchases that don’t represent a critical need are abstained upon. Following a surge in spending in the post-pandemic period – the so-called retail revenge phenomenon – this deflationary shift in the consumer economy is an important condition to monitor.

Earnings in Focus

Finally, investors have a wealth of quarterly earnings disclosures to digest. While it’s impossible to give a comprehensive breakdown of all the important players, investors should key in on Avis Budget (CAR), the car rental firm which may provide a real-time indicator of travel sentiment. Avis releases its second-quarter results on Monday.

On Tuesday, all eyes will likely be on digital payments and financial technology specialist PayPal (PYPL). While the company has been a huge beneficiary of the shift to digitalization during the immediate aftermath of the COVID-19 pandemic, PayPal has suffered a reversal of fortunes, shedding nearly 56% of market value on a year-to-date basis.

On Thursday, Cheniere Energy (LNG) will take the spotlight. Not only will analysts dig into its Q2 results, Cheniere is especially relevant because of the Ukraine crisis. Combined with an unexpected heat wave in Europe, energy needs in the region are soaring, cynically boding well for LNG stock.

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