Stocks plunge as inflation squeezes profit margins

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Stocks fell sharply on Wednesday after back-to-back earnings reports from Walmart and Target raised concerns about consumer goods profit margins.



5 minute read

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Key points to remember

  • Big shortfall per goal raises concerns over profit margins

  • Weak housing reports hammer real estate stocks

  • Falling transportation stocks could be a bearish signal for some investors

Shawn Cruz Director of Derivatives Strategy, TD Ameritrade

(Wednesday market close) Stocks fell sharply on Wednesday as profits from major retailers, including Target (TGT) and walmart (WMT) failed due to inflation. Target plunged 24.93% in reaction to its earnings announcement on Wednesday while Walmart has now fallen nearly 18% since Monday’s earnings release. These two companies at the top of the retail trade seemed caught off guard by their results and did not expect any improvement anytime soon.

Other retailers dove into the news, leading the Dow Jones US Retail Index down 7.69% on the day. Within this group were Amazon (AMZN) losing 7.16% and Kroger (KR), down 6.5%. Big discount stores with the smallest profit margins have also felt the pain as dollar tree (DLTR) fell 14.42% and five below (FIVE) slipped 11.54%.

New housing data showed that the Fed’s rate strategy is weighing heavily on the housing market. Building permits fell 3.2% in April and housing starts fell 0.2%. Additionally, mortgage applications fell 11% last week. the PHLX Housing Sector Index fell 4.64%.

The market sell-off was broad and severe, sending the Dow Jones Industrial Average ($DJI) down 1,164 points for a daily loss of 3.57%, while the Nasdaq Compound ($COMP) plunged 4.72% as the S&P500 (SPX) fell 4.4%. The S&P 500 closed below 4000 and may not see support until the 3700 level. Cboe Market Volatility Index (VIX) climbed back above 31 as investor fears over inflation and profit margins grew.

All sectors were down that day, but the Index of Selected Consumer Discretionary Sectors and the Core Consumption Select Sector Index were the lowest, dropping 6.59% and 6.48% respectively. Consumer goods are being squeezed by rising inflation as producers struggle to pass on rising input costs to consumers. While some are seeing record sales, the numbers have been skewed by rising inflation as stores sell few units. This is the stagflation scenario where the economy is slow, but inflation is still high.

Selling wasn’t just in the stock market – commodities also lost ground. the WTI Crude Oil Futures fell 2.5% and RBOB Gasoline Futures slid 6.58% despite news that Finland and Sweden are taking steps to join NATO. Russian President Vladimir Putin has warned both countries against the move and promised repercussions. However, oil and gasoline prices fell in trade despite rising costs at the pump which could slow the summer travel season. the Dow Jones US Travel and Leisure Index fell 4.63% and is back below its late 2020 highs.

Investors fled to the safety of bonds, pushing prices up and yields down. the 10-year Treasury yield (TNX) fell 82 basis points to 2.886%.

CHART OF THE DAY: BROKEN-DOWN. The Dow Jones Transportation Average (DJI – candlesticks) broke through the full range of support levels. Data sources: ICE, S&P Dow Jones indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Dow Theory Warning Sign

Dow theorists are investors who follow the writings of Charles Dow, co-founder of Dow Jones & Company and the Wall Street Journal. One of the tenets of Dow Theory is that carrying actions are a signal of economic strength. If raw and finished materials are always shipped, the economy is strong. Transportation is actually a broader but cruder measure of the economy than gross domestic product (GDP) which focuses only on finished goods.

A bearish signal occurs when the Dow Jones Transportation Average ($DJT) and the Dow Jones Industrial Average ($DJI) both trended lower in today’s trading. I refer you to a Dow theorist for the intricacies and nuances of how to interpret charts.

Meanwhile, another measure of the economy that is broader than GDP is gross output (GO). GO is actually released with GDP and measures total economic activity by tracking all production of new goods and services. This means that GO measures all stages of the economy, including resources, production, distribution and final output, known as GDP.

According to economist Mark Skousen PhD, the drop in GO tends to precede a recession. Unfortunately, GO only comes out on a quarterly basis, but the latest numbers have indicated a slowing economy but not a recession, yet. The GO numbers may confirm the stagflation picture of slowing economic growth and higher inflation.

Notable Calendar Items

May 19: Philadelphia Manufacturing Index, Existing Home Sales and Revenue from Salesforce (CRM), Applied Materials (AMAT) and Kohls (KSS)

May 20: Earnings from Deere & Co. (DE) and Foot Locker (FL)

May 23: Earnings from Advance Auto Parts (AAP)

May 24: New Home Sales and Earnings of Intuit (INTU), Best Buy (BBY), Ralph Lauren (RL), Toll Brothers (TOL) and Nordstrom (JWN)

May 25: Durable Goods, FOMC Meeting Minutes and Revenues from NVIDIA (NVDA), Splunk (SPLK), Williams-Sonoma (WSM) and Dick’s Sporting Goods (DKS)

good trade,

Shawn Cruz

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