Wall Street Breakfast: What Moved Markets

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Wall Street Breakfast

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The stock market closed the week on a sour note after U.S. inflation accelerated to a fresh 40-year high and consumer sentiment plunged to a record low. Friday's selloff was broad, with all 30 Dow stocks closing lower and decliners outnumbering advancers on the New York Stock Exchange by 8 to 1. The hot inflation numbers, which showed inflation soaring 8.6% on an annualized rate, sparked heightened concerns about a recession and more aggressive interest rate policy from the Federal Reserve starting at next week's meeting. The 2-year Treasury yield, considered highly sensitive to Fed rate hikes, spiked 22 basis points to 3.04%, its highest level since 2008. For the week, it was the worst showing for stocks since January, with the Dow diving 4.6%, the S&P 500 shedding 5% and the tech-heavy Nasdaq Composite plunging 5.6%.

Buy Now, Pay Later

Making waves in the short-term financing industry, Apple (NASDAQ:AAPL) unveiled a BNPL service during its Worldwide Developers Conference on Monday. The "Pay Later" program will operate out of a wholly-owned subsidiary called Apple Financing LLC, which has the necessary state lending licenses to offer the feature. The new service will turn Apple into somewhat of a bank (though it doesn't have a charter) as it makes financial services a deeper part of its ecosystem.

How it works: Users will be able to split the cost of an Apple Pay purchase into four equal payments, spread over six weeks, with zero interest and no fees. The plan will be available everywhere Apple Pay is accepted - in app and online - while upcoming payments can be tracked via the Apple Wallet. If loans aren't repaid, Apple will no longer extend credit to those users, though the company said it won't report the missed payments to credit bureaus.

"Pay Later" will compete against similar offerings from Affirm (AFRM), Klarna (KLAR) and PayPal (PYPL), where it will earn interchange fees and valuable data from each transaction. Official BIN sponsor Goldman Sachs (GS) will give access to Mastercard's (MA) network, providing the ability to issue payment credentials directly. In the past, Apple has worked with Goldman to issue the Apple Card in the U.S., while partnering with Barclays (BCS) in the U.K. to offer financing for purchases of its devices.

iBank? Under the new program, Apple will handle credit checks, underwriting and lending, but is likely to continue to use licensed partners for its financial operations in the near future. Getting and maintaining a banking license would be a big headache for the company and may see it stray too far from its mission statement. To note, banking in general is a relatively low-margin business and Apple would be subject to severe regulations and reporting requirements, which could be considered a big risk for the tech giant. (46 comments)

Clearing inventory

Retail earnings have been incredibly scattershot in May and June, with winners and losers seeing wildly differing share reactions and revealing important insights on specific subsectors. One of the biggest losers has been Target (TGT), whose share price has tumbled 30% since reporting Q1 results on May 18. Earnings came in far from the bullseye after higher costs whacked profitability, but the company had another surprise in store for investors after slashing guidance on Tuesday.

Financial front: Target now sees its operating margin rate falling to a range of around 2.0% for Q2 vs. the ~5.3% estimate projected in late May (and 6.5% consensus). That's a drastic drop, though it does hope to jump back to around 6.0% in the latter half of the year. The company also continues to expect full-year revenue growth in the low- to mid-single digit range.

The biggest issue facing Target has been its selection of inventory, which grew 43% Y/Y in the latest quarter. Consumers have been shifting away from higher-margin goods such as kitchen appliances and TVs to basics like food and toiletries, as discretionary spending takes a hit from the current inflationary environment. "We did not anticipate the rapid shifts we've seen over the last 60 days," CEO Brian Cornell said back in May, adding that challenges would persist as Target continues to set prices based on "value and affordability."

Call to action: The retailer announced a series of steps to "right-size" its inventory for the balance of the year, like additional markdowns and order cancellations. The action plan also includes incremental holding capacity near U.S. ports to add flexibility and speed in the portions of the supply chain most affected by external volatility. Other retailers with way too much inventory include Walmart (WMT), which saw a 33% Y/Y increase in merchandise last quarter, and Kohl's (KSS), whose stash of goods rose by 40%. (82 comments)

Stock trades

The SEC said it would consider some changes to stock-market rules that would make trading firms directly compete to execute trades from retail investors. Some of the proposals were outlined on Wednesday as Chairman Gary Gensler took the stage at the Piper Sandler Global Exchange Conference. Closely watching the speech were online brokers like Robinhood (HOOD), TD Ameritrade (SCHW) and E*TRADE (MS), as well as the New York Stock Exchange (ICE) and Nasdaq (NDAQ).

Backdrop: The news comes about a year after Gensler said the agency staff would review best execution requirements - which require brokers to process customers' orders at prices advantageous to the customer. Specifically, payment for order flow (PFOF), where brokers farm out retail orders to firms like Virtu Financial (VIRT) and Citadel Securities in exchange for a fee. The scrutiny of the industry grew out of the trading frenzy surrounding GameStop (GME) and other meme stocks in early 2021, triggering discussion over execution quality and price performance.

Online brokers contend that PFOF, which allows commission-free trading, has opened up investing to millions of young people, including women and minorities who hadn't previously invested in the markets. "The current market structure has resulted in tighter spreads, greater transparency, and meaningfully reduced costs," a Citadel Securities spokesperson told Bloomberg. Opponents disagree, saying PFOF includes hidden fees that investors are paying without knowledge and it also gives huge trading firms data on where the market is heading.

Go deeper: Upcoming changes could require retail orders to be sent to a type of auction in the hopes of improving execution transparency, lowering access fees and allowing exchanges to quote shares in increments under one cent. Improvements could also be made to execution rules, which permit brokers to find the best possible terms for their customers. "Efforts to modernize the best execution requirements will be met with some degree of conceptual support, but this issue carries slightly more political and operational baggage than the tick size and access fee proposals," noted BTIG analyst Isaac Boltansky. (18 comments)

Twitter endgame

Things got a bit more chaotic in the Elon Musk-Twitter (NYSE:TWTR) saga after the billionaire warned that he could walk away from the $44B acquisition if the platform does not provide detailed information on spam and fake accounts. "This is a clear material breach of Twitter's obligations," Musk's lawyers wrote in a letter, adding that the company was "actively resisting and thwarting his information rights." In the past, Twitter CEO Parag Agrawal has said he "doesn't believe that this specific [bot] estimation can be performed externally, given the critical need to use both public and private information (which we can't share)."

Snapshot: It's even more interesting as Elon Musk didn't want to do any extensive due diligence when abruptly announcing the deal back in April. At the time, he wanted to complete the acquisition as soon as possible, but then slammed the brakes over the bots issue, which is not the first time the topic has surfaced. While Musk has agreed to pay $54.20 per share for Twitter, the company's stock price is now trading at $39.56, which is significantly lower than where things stood even several weeks ago. "It's fairly obvious that Musk has buyer's remorse and he is trying whatever to get a reduction in price, and I think he may succeed," said Dennis Dick, a prop trader at Bright Trading.

From a legal perspective, the only way Musk could abandon the deal is a refusal from the banks to provide financing or regulators block the transaction. Lawyers for the Tesla (TSLA) CEO may be trying to link the bots issue to his ability to secure financing, allowing him to walk away by paying a $1B breakup fee (Texas on Monday opened a separate investigation into Twitter's alleged fake accounts based on the state's Deceptive Trade Practices Act). However, Twitter's disclaimers used in its projections on spam accounts and a "specific performance" clause could give it protection against potential lawsuits, and Musk would have to prove that he was willfully misled (which is a high legal threshold).

Outlook: Twitter intends to enforce the merger pact on the agreed-upon terms, but could renegotiate if it sees a protracted legal battle or maneuvering for Musk to wiggle out of a deal. Later in the week, the company also offered Musk a data "firehose" and agreed to hold a shareholder vote by August. Twitter stockholders are not the only ones watching the show as Tesla investors also have an indirect financial interest in the outcome of the corporate drama. (282 comments)

Recession talk

The national average price at the pump has surpassed $5.00 per gallon, according to GasBuddy, an industry consultant that surveys prices at more than 150K stations nationwide. The average from AAA is also likely to reach that level this weekend, with prices standing at $4.986 per gallon as of early Friday. For energy investors, the supply-demand imbalance appears most acute in the refining sector, where names like Valero (VLO), HF Sinclair (DINO) and Par Pacific (PARR) stand to benefit from record margins, while integrated producers like Exxon (XOM), BP (BP) and Chevron (CVX) are better equipped to manage a refining bottleneck than upstream peers.

Recession worries: It's unclear where the breaking point is, but gasoline underpins much of the economy, from transport and travel to production and construction. It also guides a significant amount of consumer behavior, as well as inflation expectations, which can have even more damaging consequences on the economic outlook. Many see trouble in store if fuel prices continue to rise, or stay at elevated levels for an extended period of time, though Treasury Secretary Janet Yellen said Thursday that "there's nothing to suggest that a recession is in the works" after admitting last week that she was wrong about the trajectory of inflation.

Rule of 10? There's a theory out there that the U.S. economy generally runs into trouble when interest rates (the cost of money, which everyone uses) together with energy prices (the cost of energy, which everyone uses) reaches double digits. To calculate the indicator, the average rate on the 30-year fixed-rate mortgage (5.23% as of Thursday) is added to the prices at the pump (now averaging $5). The rule was coined by Strategas chief economist Don Rissmiller in 2011, when the U.S. was still recovering from the global financial crisis.

Commentary: "The economy is definitely on thin ice here, but I don't think we're there yet," said Mark Zandi, chief economist at Moody's Analytics. "If we get to $5.50 or $6 [gasoline], that would be consistent with $150 for a barrel of oil. I think then, we're done. We're in for a recession. It would be too much to bear. I think we could digest $120 [oil] if we don't stay there too long." (18 comments)

U.S. Indices
Dow -4.6% to 31,393. S&P 500 -5.1% to 3,901. Nasdaq -5.6% to 11,340. Russell 2000 -4.4% to 1,800. CBOE Volatility Index +11.9% to 27.75.

S&P 500 Sectors
Consumer Staples -2.6%. Utilities -4.1%. Financials -6.8%. Telecom -4.1%. Healthcare -3.4%. Industrials -5.%. Information Technology -6.4%. Materials -5.8%. Energy -0.9%. Consumer Discretionary -6.1%.

World Indices
London -2.9% to 7,318. France -4.6% to 6,187. Germany -4.8% to 13,762. Japan +0.2% to 27,824. China +2.8% to 3,285. Hong Kong +3.4% to 21,806. India -2.6% to 54,303.

Commodities and Bonds
Crude Oil WTI +1.4% to $120.47/bbl. Gold +1.4% to $1,875.2/oz. Natural Gas +2.7% to 8.755. Ten-Year Bond Yield -0.2 bps to 3.165.

Forex and Cryptos
EUR/USD -1.88%. USD/JPY +2.71%. GBP/USD -1.38%. Bitcoin -1.9%. Litecoin -9.6%. Ethereum -7.2%. XRP -1.9%.

Top S&P 500 Gainers
The J. M. Smucker (SJM) +5%. Valero Energy (VLO) +4%. Brown-Forman (BF.B) +3%. Domino's Pizza (DPZ) +3%. The Kraft Heinz (KHC) +3%.

Top S&P 500 Losers
Royal Caribbean Cruises (RCL) -19%. Carnival Corporation & plc (CCL) -18%. Norwegian Cruise Line Holdings (NCLH) -16%. Warner Bros. Discovery (WBD) -15%. Expedia Group (EXPE) -13%.

Where will the markets be headed next week? Current trends and ideas? Add your thoughts to the comments section.

This article was written by

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