[Chart courtesy of MarketWatch.com]

1. Moving the markets

The markets were caught off guard by a double whammy of bad news, and they took a dive. On one hand, bond yields rose again, signaling higher borrowing costs and inflation fears. On the other hand, China’s economy showed signs of slowing down and struggling with debt.

Meanwhile, the US economy seemed to be doing well, at least on the surface. Retail sales in July beat expectations, rising by 0.7% month-over-month and accelerating year-over-year. This was the best performance since January.

But as traders know, good news can be bad news when it comes to the Fed. The strong retail sales data could mean that the Fed will not pause its rate hikes anytime soon.

The banking sector was hit hard by a warning from Fitch, a rating agency, that it might downgrade dozens of banks and put others on a watchlist. I told you months ago that the banking crisis was not over yet, and neither was the inflation monster.

Fed official Neel Kashkari added some fuel to the fire by calling for more capital regulations and more rate hikes to tame inflation. He said that if inflation got out of control, the banks could face more losses and more pressure in the future.

No kidding: we haven’t seen the worst of it yet.

Homebuilder confidence also took a hit today, as the housing market cooled off amid rising costs and supply shortages.

The major US stock indexes got clobbered, with the S&P 500, Nasdaq and Small Caps dropping below their respective 50-day moving averages. Bond yields ended the session mixed, the dollar held on to yesterday’s gains, and gold tested its 200-day moving average and found support.

And just for fun, here’s a chart from ZeroHedge that compares the S&P 500 today with its performance in 1987, right before the infamous Black Monday crash.

No… that can’t happen again, right?

[Chart courtesy of MarketWatch.com]

1. Moving the markets

The U.S. consumer is in the spotlight this week, as three retail giants – Home Depot, Target, and Walmart – are set to report their earnings. We’ll also get a glimpse of how shoppers spent their money in July, with the retail sales data coming out on Tuesday morning.

These reports come on the heels of last week’s inflation data, which showed that prices are still rising faster than the Fed’s 2% target but not as fast as they did in the previous months. Is this a sign that inflation is cooling off, or just a temporary blip?

Two weeks ago, I asked ‘What’s next?’ for the markets, and the answer was ‘not much’. The markets have been choppy and directionless, waiting for more clarity on the economy and the Fed’s next move. That hasn’t changed much this month.

But in the dog days of August, when investors have more time to daydream, some are starting to wonder if there are other scenarios besides a Goldilocks soft landing. Maybe the news flow isn’t as rosy as it was earlier this summer. Maybe there are some risks lurking in the shadows?

Some traders are trying to brush off the August slump by saying that it’s healthy and normal, and that it doesn’t mean the end of the bull market. They seem to forget that the rally was based on a lot of speculation and hope that the Fed would cut interest rates soon. But today’s data showed that rate hike expectations are rising, not falling, as this chart shows.

The chart shows the implied probability of a rate hike by December 2023 based on fed funds futures contracts.

The major indexes managed to close slightly higher today, but the small caps were left behind. NVDA had a rough start, but recovered and crossed its 50-day moving average, just in time for the AI boom downturn. Look at this chart.

Bond yields had a wild ride today, ending higher after a dip in the middle of the day. The 2-year yield is on track to hit 5% soon. The dollar gained some strength, which weighed on gold prices. Oil prices were aimless and ended lower.

The big event of the week will be Home Depot’s earnings report on Thursday. The company has more impact on the S&P than Walmart and Target combined. But it has missed expectations for two quarters in a row.

Will it break the streak, or break the market?

[Chart courtesy of MarketWatch.com]

1. Moving the markets

The latest consumer price index (CPI) report showed that inflation in July was lower than expected on a yearly basis, but still higher than the Fed’s comfort zone. The report also indicated that real average weekly earnings did not change last month, which could be seen as a positive sign for consumers.

However, the report also revealed some signs of persistent inflation. The core CPI, which excludes food and energy, rose 4.7% year-over-year, well above the Fed’s 2% target. And the headline inflation rate was still above 3%, the same as in June.

The market reaction was mixed and volatile. Initially, traders and algorithms focused on the lower-than-expected annual inflation rate and pushed the Dow up by more than 400 points. But later, they realized that the data might not be enough to convince the Fed to delay tapering its bond purchases, and the rally fizzled out. The major indexes gave up almost all early gains by the end of the day.

ZeroHedge summed it up best:

A quiet illiquid summer day which saw oil pump-and-dump, bond yields drop-and-pop, stocks spike-and-puke, gold jump-and-slump, and the dollar purge-and-surge.

It seems that nothing much changed in the big picture, but the AI boom reversal prediction is still on track.