Key Takeaways
- Moody’s downgrade sparks volatility, but long-term equity impact uncertain
- Retail earnings, tariffs, and sentiment may shape market direction next
- 30-year bond yields climb; VIX rise signals growing investor anxiety
The S&P 500 is coming off a five-day winning streak, gaining 4.5% last week, and all the major indices posted healthy gains as well. The Nasdaq Composite added 6%, the Russell 2000 was higher by 4% and the Dow Jones Industrial Average was up 2%. However, after the close on Friday, a downgrade on U.S. credit sent futures falling.
Moody’s Ratings, which was the last agency with a AAA rating on U.S. credit, downgraded the U.S. to Aa1, which puts the U.S. in the same category as Austria and Finland. The downgrade was the result of large fiscal deficits and rising interest costs. The news sent stock futures lower when they opened Sunday night along with bonds. Rates on the 30-year bond also broke above 5%.
While other credit rating agencies downgraded the U.S. in 2011 and then in 2023, the effects didn’t seem to have a lasting impact. After initially selling off in the immediate aftermath of the downgrades by Standard & Poor’s and Fitch, equity markets resumed their march higher. Therefore, while it’s understandable why equity and bond markets are lower this morning, I’m not convinced the downgrade, in and of itself, will be long-term detrimental for equities. That is especially true if we continue seeing earnings performances like we’re seeing this quarter.
After a relatively quiet week last week on the earnings calendar, this week will be interesting with a number of retailers reporting results. Thus far, earnings are on pace to be up 13.6% according to FactSet. If there are any concerns with respect to earnings, I would say valuations and the potential impact of tariffs are two. The 12-month forward looking P/E of the S&P 500 is modestly elevated at 21.4. That is above both the five and ten-year averages of 19.9 and 18.3, respectively. The other potential headwind facing earnings is tariffs. The frequency with which tariffs are being mentioned is at a ten-year high and, as I’ve mentioned before, there is a significant amount of forward-looking guidance hedging taking place. A number of companies have offered guidance based on different macroeconomic scenarios and it’ll be interesting when second quarter earnings are announced, how the various narratives are spun.
On the calendar this week, we have earnings from retailers such as Home Depot, Target, TJX, and Ralph Lauren. The potential tariff impact will be especially profound in the retail space. Just recently, Walmart warned they would have to raise prices on consumers, which resulted in a rebuke from the White House, when President Trump said Walmart should “eat the tariffs” along with China. Tangentially related to retail earnings are the Consumer Expectations and Sentiment numbers that were released Friday. Pessimism continues rising with consumers expecting inflation to hit 7.6% in the next twelve months. A dour outlook by consumers could have as much an impact on earnings as tariffs.
For today, I’m keeping an eye on both bonds and volatility. The rate on the 30-year bond is approaching levels we haven’t seen since 2007. That is something worth watching. I’m also watching the VIX which is already up over 12.5% in premarket trading. After getting down near its historical long-term average of 16, we’re back near 19.5. A break above 20 would be concerning as that tends to become the level at which pullbacks become more violent. As always, I would stick with your investing plan and long-term objectives.
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