Soft consumer data complicates the “Bad news is good news” trade as markets

Revisiting — The Bad News is Good News argument...

Good morning — and be careful what you wish for.

For weeks now, investors, traders and the algo’s have been begging for softer economic data — specifically, softer inflation data. They want inflation to cool enough to take a September rate hike off the table while the economy, the consumer and corporate earnings continue to hold up.

That would be called the sweet spot.

But on Friday, the conversation got a little more complicated. Stocks backed off Thursday’s record high after the latest economic data suggested that the economy’s main engine - the consumer - may be starting to cool.

At the end of the day, the Dow lost 108 pts, the S&P gave back 13 pts, the Nasdaq lost 74 pts, the Russell gained 17 pts, the Transports lost 135 pts, the Equal Weight S&P ended the day flat, while the Mag 7 lost 80 pts.

Seven of the 11 S&P sectors advanced while four lost ground. Energy was the standout - up 1.4% - while Healthcare lost 0.6%. Everyone else was somewhere in between.

And then there was tech – 0.4%. AMAT got whacked - down about 5% - despite delivering solid numbers and an upbeat forecast. But remember - AMAT had already had an enormous run this year, up 102%. So while nobody wants to see a 5% hit, let’s put it into perspective. It’s a pimple on your a..!

What the reaction DID remind us of is this - Good isn’t always good enough when expectations are priced for perfection. The weakness spilled into other chip names and helped pressure the Nasdaq. ASML, LAM, and TSM all moved lower. This morning – AMAT is quoted up $8 or 1.5%.

Ok - let’s go back to the eco data because THAT raises a new question. For months the conversation has been: Will stubborn inflation force Kevy and the FED to raise rates again? One day it’s yes, the next day it’s no...

Well, on Friday we got retail sales - and boy was that a surprise. July retail sales fell 0.6% m/m - the biggest decline in more than a year and well below expectations that expected a 0.1% increase.

Even more important, the so-called control group - the number that feeds more directly into GDP - fell 0.4% versus expectations for a 0.3% gain.

And suddenly investors had to ask: Is the consumer beginning to slow?

Now, before you go lighting your hair on fire — retail sales are still up about 5% y/y and there is another important wrinkle to consider. Amazon moved Prime Day - which is now really Prime Week - from July to June this year. It ran from June 23–26, which means some spending that normally would have occurred in July got pulled back into June.

That likely contributed to some of the weaknesses, but one month does NOT make a trend.

Then at 10 a.m. we got another data point. The U of Michigan Consumer Sentiment Index fell to 51, down from 55.2 in July and below the 54.5 expectation.

And that means what? The consumer isn’t feeling particularly good about his or her situation. And on top of that - inflation expectations actually got worse. One-year inflation expectations ticked UP by 0.1% to 4.3%, while five-year expectations held at 3.3%. And suddenly the market is staring at an uncomfortable combination - A softer consumer, weaker employment data, elevated inflation expectations and oil moving higher again.

And here’s the problem with that - The market wants cooler inflation - NOT a weaker economy. If inflation continues to ease while the consumer and the economy remain strong, then Kevy and the FED can stay on hold and everybody’s happy. That’s the soft-landing scenario.

But if the consumer really starts to crack and the economy begins to roll over, then the conversation changes completely. Suddenly we’re not debating whether the FED hikes or holds. We’re debating about when they HAVE to start cutting rates. And THAT is not the kind of bad news investors should be cheering.

That’s when we revisit the other side of this argument when Bad News is Bad News. Recall - Bad news is good news when the economy is cooling just enough to reduce inflation pressure and keep the FED from raising rates — without threatening economic growth.

Bad news is bad news when the data gets weak enough that investors stop celebrating lower rates and start worrying about slower growth, weaker consumer spending and declining corporate earnings. (Which, by the way, hasn’t happened yet.) Or put another way - Cooling is good. Cracking is not.

And that’s why Friday’s weak economic data didn’t produce the kind of rally the “bad news is good news” crowd might have expected because there is a BIG difference between the FED not needing to hike because inflation is cooling and the FED having to cut because the economy is weakening.

Now - Friday’s data sent the fed-funds futures market into a tizzy. The odds of a September rate hike are now 31%, vs. 51% last week and 70% two weeks ago. In fact, fed-funds futures aren’t pricing in another hike this year. So, somebody better tell the people at Bank of America’s Global Research team - because they’re still calling for three rate hikes before year-end. And that’s funny...Because there are only three FOMC meetings left in 2026!

Then there were the bonds - because THIS is where Friday gets even more interesting. Treasuries initially rallied following the weak retail-sales report, sending yields lower - exactly what you would expect.

And then? They reversed course. The TLT lost 0.7% while the TLH lost 0.6%, leaving the 10-year yield at roughly 4.69% and the 30-year at 5.25% — even though the economic data was weaker and the odds of a September FED hike fell.

The bond market essentially said – ‘OK’ - maybe Kevy doesn’t have to raise rates in September. But don’t confuse that with the inflation problem being solved.

And THAT is the message you need to pay attention to.

Then there’s oil. WTI gained another $1.15, or 1.4%, to settle at $82.40, while Brent gained roughly 1.7% to $88.50. For the week, WTI gained more than 5% while Brent gained about 6%. And this morning it is up 25 cts at $82.65.

Why? Because despite all the talk and all the negotiations — there is still NO deal.

Last week - Two UAE-linked tankers were attacked in the Strait of Hormuz, the UAE blamed Iran, U.S./Iran talks remain stalled and Washington is threatening to maintain — and potentially increase — the economic pressure and naval blockade.

In addition – the 60-day MOU (memorandum of understanding) between Iran and the US – has now expired. OK – so then you ask – How come oil isn’t trading even higher?

Well, here’s the other side of the oil story - and it helps explain why crude is at $82 and not $120 or $150.

More oil IS getting out of the Gulf. Gulf producers have created what amounts to a “dark shuttle” system - moving crude through the Strait of Hormuz on ships with their transponders turned off, transferring those barrels onto larger tankers waiting in the Gulf of Oman, and then sending them on to customers around the world.

Estimates had put those flows at around 4 million bpd, but last week, US Energy Secretary Chris Wright said roughly 9 million bpd had moved through the strait over the prior seven days.

And THEN add the pipeline workarounds - especially Saudi Arabia’s ability to move crude west across the country and out through the Red Sea - along with stockpile releases and supposed softer global demand.

So, while the Strait is clearly NOT operating normally, the oil isn’t trapped either. And THAT helps explain why WTI has spent much of August in the $75–$85 range instead of exploding toward the $100 disaster many analysts were talking about when this conflict began.

But don’t misunderstand the message. The risk hasn’t disappeared - the market has simply found a workaround. Ships are still being attacked, crews have been killed and injured, insurers are taking on enormous risk, and these shipments can be disrupted at any moment.

So, while this is keeping a lid on the geopolitical risk premium, if Iran get more aggressive or tries to blow up those alternative pipeline routes - then we’ve got a very different oil story.

So now you’ve got this strange dynamic. Cooler CPI and PPI say the FED can stay on hold. Oil above $82 and Brent pushing toward $90 says -Don’t get too comfortable. All while 10 yr sits near 4.70% saying the bond market isn’t buying the all-clear signal just yet.

Gold understood the message as well - rising again on Friday as weaker U.S. economic data, a softer dollar and geopolitical uncertainty continued to support the safe-haven trade. Gold remains comfortably inside our $4,150/$4,500 trading range. This morning – gold is trading up $18 at $4,394.

But let’s not lose sight of the bigger picture. Second-quarter S&P earnings growth has been spectacular — aggregate earnings are running more than 50% above last year’s level. Now, that headline number is being amplified by some enormous investment-related gains at a handful of mega-cap companies - gains that count as GAAP earnings but aren’t the same thing as profits generated by selling more products, growing cloud revenues or improving operating margins.

So, you have to look under the sheets and when you do – you’ll find that corporate earnings growth is STILL very strong. Which is the point. Corporate America continues to deliver, and one weak retail-sales report should NOT cause you to suddenly reallocate your portfolio.

Eco data this week includes – Empire Manufacturing today. Tomorrow brings us Housing Starts expected to be down 6% - recall it surged 19% in June, Building permits of +0.1%, Industrial Production of +0.1%, Capacity Util of 76.3%.

And here’s something else to watch in housing.

There is growing momentum in Washington to raise the capital-gains exclusion on the sale of a primary residence - currently $250k for an individual and $500k for a married couple filing jointly - with proposals aimed at increasing those limits to $500k and $1 million - reducing the tax penalty for longtime homeowners who want to sell.

Why does that matter? Because there are plenty of baby boomers sitting in homes they bought decades ago with enormous, embedded gains who may be reluctant to sell because of the tax bill. Raise the exclusion and maybe you convince some of them to finally sell. And what happens then? More existing homes come onto the market. More supply means more choices for buyers - and potentially more competition for homebuilders.

Wednesday brings us the July FOMC mins and while I don’t think we’ll learn anything new – we may get a hint at other members who were leaning a bit more hawkish but didn’t fully dissent like Logan, Hammack and Kashkari did. Friday brings us the preliminary August Services and Manufacturing PMI’s – and both are expected to remain in the expansion zone.

And then there’s earnings. This is consumer week. And if you really want to know whether the consumer is starting to crack - forget the economists for a minute and listen to what the companies have to say.

HD & LOW is about housing, remodeling and big-ticket spending. TGT is about the discretionary middle-class consumer. TJX & ROST are about are consumers trading down and hunting for value? WMT - food, necessities, discretionary goods and e-commerce while BJ’s is about the warehouse/value consumer. In other words - we’re about to get a LOT more information on whether Friday’s weak retail-sales report was a one off or something more to consider.

We’ll also hear from DE, PANW, TOL and MDT — giving us a look at agriculture and industrial equipment, cybersecurity, housing and medical devices.

European markets are mixed…. Spain is down 0.3% while Italy is up 0.3%. UK and Germany are flat, France is down 0.2%.

US futures are also mixed – Dow futures are down 75 pts, S&P’s up 10, Nasdaq is up 140 while the Russell is down 5 pts.

The S&P closed at 7,785 – down 13 pts…. futures action this morning is suggesting another day of consolidation…. Near term support is 7700… Trendline support is at 7500 with resistance somewhere between 7,900/ 8,000. Year end estimates are now being revised higher…. Ed Yardeni is the latest guru to raise his yr end target to 8400 (up from 8250).

We are now in the final 2 weeks of summer - expect trading volumes to decline over the next two weeks, which means moves can be exaggerated in either direction.

I’m still in the camp that we could see another draw down as we move into September. We can point to the same concerns – inflation, rates, mid-terms, valuations and the ongoing conflict in the middle east. The decline in trading volumes can amplify the move – in either direction. Remember - The economy is still growing. Corporate earnings remain strong. The S&P is kissing record highs. You are invested, you have a plan, so stick to it.