8-18-13 9:35 AM EDT | Email Article
 

By Wallace Witkowski, MarketWatch

 

SAN FRANCISCO (MarketWatch) -- U.S. stocks face continued challenges and a further push off recent highs as more retailers report earnings this week and Federal Open Market Committee meeting minutes are released.

 

The S&P 500 Index (SPX) and the Dow Jones Industrial Average (DJI) are 3.1% and 3.7% below their respective all-time highs set in earlier in the month, after they both closed down about 2% this past week.

 

Yields on the 10-year Treasury (10_YEAR) surged more than 20 basis points this past week to their highest level in more than two years, notching a 75% rise since bottoming out in mid-May, following generally improving economic data in the U.S. and abroad.

 

Stocks are going to fall with a jump in interest rates, but that's more a short-term issue for traders and should be less of one for the long-term investor, said Dan Greenhaus, chief global strategist at BTIG LLC.

 

"There might be more downside to the market if interest rates keep moving higher," Greenhaus said. "The question is whether it's permanent."

 

For example: After the yield on the 10-year note jumped about 100 basis points from early May to late June, the S&P 500 fell about 5% off its May high. But the setback was only temporary. The S&P 500 rose 8% over the next six weeks as the yield on the 10-year stayed fairly steady.

 

(Read more on The Tell: Rising interest rates really aren't that bad for stocks, past rate cycles suggest: http://blogs.marketwatch.com/thetell/2013/08/16/rising-interest-rates-really-arent-that-bad-for-stocks/.)

 

More pain for retail this week?

 

While more than nine-tenths of S&P 500 companies have already reported earnings this season, many big-name retailers are set to report this week, and that could bring with it little reason to cheer.

 

This past week saw August consumer sentiment taking a turn for the worse, while Wal-Mart Stores Inc.(WMT) and other retailers reported cautious consumer spending.

 

That pullback in spending, along with weak earnings from retailers and a considerable decline in outlook is cause for concern.

 

"I think there's something going on and not just part of the seasonal weakness," said Savita Subramanian, Bank of America Merrill Lynch equity and quant strategist. More consumer discretionary companies are falling short of earnings and revenue expectations this season with the rate approaching 20%, a high not seen since the fourth quarter of 2011, she noted.

 

Also, in the past month, consumer discretionary companies have slashed their forward guidance dramatically compared with the rest of the S&P 500, she noted. That makes for an expensive sector. Consumer discretionary stocks are up more than 22% this year, versus the S&P 500's 16%, and most fund managers overweight the sector in their portfolios.

 

This all led her to conclude that consumer discretionary stocks are the most broadly overvalued sector on the S&P 500, prompting a downgrade of the sector as a whole from B. of A.

 

Also, higher interest rates in a low inflationary environment are likely pushing consumers to save more and spend less, Subramanian said.

 

So, expect more of the same this week when more retailers report with Urban Outfitters Inc. (URBN) on Monday; J.C. Penney Co.(JCP), Best Buy Co. (BBY) on Tuesday; Target Corp. (TGT) and Staples Inc. (SPLS) on Wednesday; and Gap Inc.(GPS), Dollar Tree Inc.(DLTR), Ross Stores Inc.(ROST), Abercrombie & Fitch Co.(ANF), and Gamestop Corp. (GME) on Thursday.

 

While grim, it's not all bad news for the consumer discretionary sector. Subramanian expects companies that rely more on business spending, such as media companies through ad revenue, to fare better than companies more reliant on consumer spending.

 

Another consequence of higher interest rates, along with a rise in housing prices, is that home owners are more likely to renovate than move, and that could bode well for home improvement companies like Dow component Home Depot Inc. (HD) and Lowe's Cos. (HD), which report this week, said Greenhaus.

 

More housing data on deck, FOMC minutes

 

With a thin data calendar this week, home sales data will be in focus with existing home sales for July on Wednesday, June FHFA home price index on Thursday, and new home sales on Friday. This past Friday, new home construction showed a 5.9% uptick for July even though forecasters had hoped for a slightly higher increase.

 

The release of FOMC minutes on Wednesday from July's meeting may also generate some market volatility owing to thin summer staffing at financial firms, according to Neal Soss, chief economist at Credit Suisse in a recent note. BTIG's Greenhaus, however, expects the minutes to add little but more color to July's meeting rather than changing the story.

 

Soss also expects July existing home sales fall to their lowest level in three months and a July decline in new home sales after three months of strength.

-Wallace Witkowski; 415-439-6400; AskNewswires@dowjones.com

 

Subscribe to WSJ: http://online.wsj.com?mod=djnwires


(END) Dow Jones Newswires

08-18-13 0935ET

Copyright (c) 2013 Dow Jones & Company, Inc.
Copyright 2014 MarketWatch
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