What’s in this week’s Report:
- Market Outlook: Will This Dip Turn Into a Pullback?
- Weekly Market Preview
- Weekly Economic Cheat Sheet
- Momentum Indicator
- FOMC Minutes Takeaway (Not That Dovish)
Futures are little changed following a quiet weekend.
Almost all the notable news from the weekend focused on the political outlook following the Bannon resignation. The news is being taken as a positive as it does increase the chances for tax cuts. But, as Friday’s price action showed (the initial bounce faded) this is not a bullish gamechanger.
Economically, is was a very slow night and there were no notable economic releases.
- FEMALE COLLEGE STUDENTS REMOVED FROM HOWARD UNIVERSITY FOR WEARING TRUMP HATS
- CNN SCRUBS HEADLINE THAT CALLS ANTIFA VIOLENT — BECAUSE ANTIFA TERRORISTS DIDN’T LIKE IT
- MATTIS ON NEW AFGHANISTAN STRATEGY — SNEAK PEEK: REMNICK ON TRUMP — BANNON TO WAPO: ‘NO ADMINISTRATION IN HISTORY HAS BEEN SO DIVIDED’ — ELISE STEFANIK’S WEDDING
- KINDLY REMINDER: BARACK OBAMA’S FAMILY OWNED SLAVES
Today there are no notable economic releases or Fed speakers, and between the quiet calendar and the eclipse, today should be a generally slow day in the markets.
S&P 500 Futures
U.S. Dollar (DXY)
There are three notable events this week that could move markets: The flash global PMIs (Thurs), the Fed’s Jackson Hole conference (Thurs-Sat) and more retailer and tech earnings (HPQ, VMW, TIF, SPLS, LOW all report this week). The Jackson Hole conference will likely end anti-climactically while the flash PMIs shouldn’t provide any shocks. However, if earnings continue to underwhelm, that could hit stocks, regardless of the macro headlines.
Last Week (Needed Context as We Start a New Week)
Stocks dropped last week as a politically inspired and tech-driven sell-off Thursday reversed what were nice gains for the markets early in the week. The S&P 500 finished down 0.65%, and is up 8.34% year to date.
Last week started strong, as the S&P 500 rallied 1% Monday on reduced North Korea tensions. On Tuesday, good retail sales and a strong Empire Manufacturing report were offset by disappointing retailer earnings (DKS, AAP, COH), and stocks ended flat on the day.
Then, after trading flat for most of Wednesday, “dovishly” interpreted FOMC minutes caused markets to rally into the close, and the S&P 500 finished up 0.14%.
However, that early week strength was completely undone Thursday, as the S&P 500 dropped 1.5%, making it the second-worst performance of 2017. The catalyst was a rumor about Gary Cohn resigning from the White House, and while it proved not to be true, it underscored the fact that prospects for tax cuts (and foreign profit repatriation) are getting dimmer by the week.
The S&P 500 fell consistently throughout the session (the terrorist attack in Spain also hit markets), and closed on the lows, and at fresh one-month lows, led down by the tech sector.
On Friday, stocks tried to steady and the markets opened flat, but they drifted very slightly lower early Friday on some mild follow-through selling.
Stocks bounced midmorning after the news that White House strategist Steve Bannon had been ousted, as that is seen as potentially positive for the passage of tax cuts. But, in what was a disappointing turn of events for the bulls, the bounce faded into the afternoon and stocks closed very slightly lower, and down on the week.
Your Need to Know
Internals from last week were pretty standard risk off, as small caps and cyclicals lagged, although notably the Nasdaq traded in line with the S&P 500.
From a sector standpoint, defensives outperformed as utilities (XLU) rose 1.41% while staples rallied 0.15%. All other SPDRs in our universe finished the week in negative territory.
Most of the outsized sector moves were news related. Super-cap tech lagged last week on concerns about no foreign profit repatriation while airlines got hit (down 1%) on the Spain terrorist attack. Homebuilders and retailers were sold on soft housing starts and underwhelming earnings. But, while internals weren’t that bad last week, the charts deteriorated as the S&P 500 closed at a one-month low.
The S&P 500 is down almost 3% from the recent highs, and hit one-month lows, but the reality is that despite the uptick in volatility, the market outlook really hasn’t changed that much. To that point, until two weeks ago, the market had enjoyed a virtually surprise-free 2017. And, the steady, consistent rally though early August reflected that.
However, things have changed a bit in the last two weeks as legitimate potential surprises have appeared, and that’s combined with seasonally low volumes and high complacency (low VIX) to cause stocks to drop.
First, there was the uptick in rhetoric with North Korea. Then, this past week, the fallout from the Charlottesville tragedy caused a rift between Trump and Republicans, and the market viewed that as reducing the chances of tax cuts in Q1 2018.
When looking back at the market reaction over the past two weeks, its critically important to factor in 1) Low attendance and 2) Low volumes as contributors to the decline.
The reality remains that 1) War with North Korea remains very, very unlikely and 2) Republicans will probably pass some sort of tax cut package if for no other reason than they want to save their jobs (2018 is an election year, after all, and Trump isn’t on the ballot, Congressional Republicans are!).
So, despite the uptick in macro noise, the keys to this market remain earnings and momentum. And while both have shown signs of weakness (earnings growth may have peaked and multiple measures of momentum are showing signs of fatigue), the bottom line is we are not getting materially more defensive in portfolios yet.
So, we continue to advocate “stagnation” positions as preferred destinations for capital: Healthcare via XLV/IHF/IBB, super-cap tech via FDN (if you’re bullish, buying this dip is worth consideration), Europe via HEDJ/EZU, defensive sectors such as utilities (XLU), consumer staples (XLP) and emerging markets (IEMG).
During last week’s Sevens Report webinar, I answered a question that basically asked what would tell me when a top was in, and my answer was this: A true momentum breakdown (so a drop in SOXX and FDN to new lows), and evidence earnings have peaked. Neither has occurred yet, so this rally must be respected.
Finally, given low volumes and liquidity, we need to be wary of “air pockets” in the market such as the one we saw in August 2015. Buying out-of-the-money puts, if you want protection, is not the worst idea between now and Labor Day. Think of it as cheap insurance against a surprise air pocket in the coming weeks.
Economic Data (What You Need to Know in Plain English)
Need to Know Econ from Last Week
There were some puts and takes from the economic data last week, but in aggregate it didn’t change the outlook for the US economy (still slow but steady growth) or the Fed (balance sheet reduction in September, a rate hike in December dependent on inflation).
I say puts and takes, because there were some decent economic reports last week, starting with a strong Retail Sales report. July retail sales beat estimates on both the headline (up 0.6% vs. 0.3%) and in the more important “Control Group” (retail sales ex-autos, gas and building materials), which rose 0.6% vs. (E) 0.4%, and saw a positive revision to June data.
That was a legitimate uptick in activity and an economic positive, although it remains to be seen whether that strength in consumer spending can be sustained past back-to-school and summer-vacation season.
The other highlights from last week were the August manufacturing surveys. August Empire Manufacturing surged to 25.2 vs. (E) 9.8 while Philly Fed Manufacturing also beat estimates at 18.9 vs. (E) 17.0. To boot, New Orders were strong in both reports (20.6 for Empire and 20.4 in Philly).
According to that type of data, we should see a big uptick in manufacturing activity in August, although I’ll again caution that these are surveys. And, unfortunately, with the exception of retail sales, the other “hard” economic data didn’t match these very strong survey results.
Specifically, July Industrial Production missed estimates, rising 0.2% vs. (E) 0.3%. But, more disconcertingly, the manufacturing subcomponent dropped -0.1% vs. (E) 0.2%. A lot of that decline was auto related, so it’s not quite as bad as it appears.
But, the overarching takeaway from last week’s data is that a wide gap remains between still-strong survey results (the PMIs) and actual, hard data (industrial production). We need that hard data to get consistently better if we have any hope of a rising economic tide carrying stocks higher for the rest of the year.
Turning to the Fed, the July meeting minutes were released last week, and while the market traded as though the minutes were slightly “dovish,” the reality is that they were neither hawkish nor dovish. The minutes confirmed that the Fed will reduce the balance sheet in September, although a rate hike in December seems very much 50/50.
Bottom line, it wasn’t a bad week for economic data, but we need evidence of economic acceleration to help push stocks higher, and that continues to be elusive.
Important Economic Data This Week
In aggregate, this is a quiet week for economic data (next week is the important week, as we get final global PMIs and the August jobs report), but there are still some potentially market-moving events to watch.
First, the Jackson Hole Policy Conference (i.e. conference/summer vacation) starts Thursday and runs through the weekend. The big names will be there: Draghi, Yellen, Carney, Fischer… but don’t expect anything that will move markets. It’s been made clear that Draghi doesn’t want to drop any hints about tapering until the ECB meeting in September (basically three weeks away). With the Fed, we know what to expect… balance sheet reduction in September.
Looking past central bankers, the key economic report this week will be the global flash PMIs, out Thursday morning. Again, we’re looking for the national PMI to match the strength we saw in Empire and Philly last week. If it does, that will be taken as an anecdotal positive. Internationally, there shouldn’t be any big surprises in this number.
Beyond the flash PMIs, July Durable Goods (Friday) is an important report, because it will give us greater insight into the state of “hard” economic data. If Durable Goods shows an uptick in corporate spending/investment, that might put upward pressure on expected Q3 GDP, which would be equity positive.
Bottom line, this week’s economic events should give more insight into the pace of the economy, but barring any big surprises, it’s likely the calm before the “storm” of next week.
Commodities, Currencies & Bonds
In Commodities, the segment was volatile last week, as a late-Friday surge on the Bannon removal caused oil and commodities in aggregate to erase large weekly declines. The commodity ETF DBC rose 0.41% on the week.
Oil and gold were the stories in the commodities markets last week, and each for different reasons. Oil initially plunged nearly 4%, although a 3% Friday afternoon rally (on the Bannon news) limited the losses. Ignoring the one-off Bannon reaction for a minute, oil was heavy last week because US domestic production continued to rise, and as we and others have been saying for some time, surging US production remains the #1 medium/longer-term force in the oil markets, and at these prices, it’s a negative one.
Oil dropped to a three-week low between the rising production and general risk-off trade that hit markets Thursday and Friday (until the Bannon news caused risk-on buying and short covering). Support around $46.00 is the next key level to the downside while $50 remains a relatively safe cap barring some production cuts from OPEC (which are very unlikely).
Turning to gold, the metal dipped slightly last week (-0.2%), but that underscores its resilience as gold got hit hard last Monday on the reduction in North Korea tensions. Also, gold managed to rally despite the stronger dollar, and the reason was general political and macro uncertainty. Gold got a boost two weeks ago from the North Korea drama, and the drop in stocks last week helped gold hold those gains.
Going forward, gold now is pressing up against resistance at $1300, and if we continue to see the global-macro outlook splinter, gold could break above resistance and accelerate higher. Gold does do well during periods of volatility (i.e. risk off) and that’s proven true again over the past two weeks.
Looking at Currencies and Bonds, the dollar rallied modestly last week thanks to euro weakness and better-than-expected economic data. The Dollar Index rose 0.4%.
If there was one, singular reason for the dollar strength, I’d say it was profit taking in the euro (down 0.48%) following the months-long, substantial rally (remember the euro is up something close to 10% YTD vs. the dollar, an amount I find quasi-absurd given fundamentals).
But, that profit taking last week was in response to slightly “dovish” ECB minutes (they did not show expected clarity on the QE tapering front, although an announcement still is expected in September). Additionally, US economic data last week was, in aggregate, better than expected.
So, the dollar traded to a three-week high vs. the euro, and given the lack of catalysts this week, baring a macro surprise, I’d not be surprised if that grind higher in the dollar continued (although to be clear, we’re still in a downtrend, and the Dollar Index needs to get into the mid-94 range near term, and above 98 longer term, to end the 2017 downtrend).
The other notable move in the currency markets was the dollar/yen, which surged during the back half of the week to trade below 109 for the first time April. Risk off was one of the main reasons for the yen strength, although there are rumblings about the BOJ potentially starting to dial back accommodation. Regardless, the surge in the yen has caught my attention, and it’s an anecdotal warning sign for stocks.
Turning to Treasury yields, they rallied early in the week but gave it all back on a risk-off bond rally when stocks collapsed Thursday. Until we get a calmer geopolitical/political environment, Treasuries will continue to be well bid. The 10 year sub-2.20%, remains, in my opinion, a significant caution sign for taking too much risk in portfolios.
Special Reports and Editorial
Momentum Indicator Update
Price action last Wednesday was a textbook bounce from the prior week’s declines. Cyclical sectors outperformed on dip buying (Nasdaq, Russell 2000) while the most beat-up sectors from last week rebounded (SOXX, FDN and BKX all traded higher that day). But that’s just an oversold bounce, and the question of whether the prior week’s decline was the start of something bigger remains unanswered, and still dependent on economic data and earnings.
Given the lack of insight from the internals last week, I want to focus on providing an update to the state of “momentum” in this market, as that’s much more important to determining the near-term direction of stocks.
Earlier this summer (late May/early June), as markets were grinding relentlessly higher despite underwhelming economic fundamentals, I identified four momentum indicators that would tell us when this market was losing momentum and when the chances for a pullback were rising.
Those four indicators are: 1) Consumer sentiment, 2) NYSE Advance/Decline line, 3) Semiconductors (SOXX) and 4) Super-cap internet (FDN). In light of the recent pullback, I want to update each of these momentum indicators and identify key support and resistance levels to watch that will tell us when momentum is breaking down, and when it’s time to hedge.
Momentum Indicator #1: Consumer Sentiment. Retail investor sentiment indicators remain overly cautious. The American Association of Individual Investors Bulls/Bears Sentiment is cautious. Now, some of this has to be taken with a grain of salt given its survey responses from last week, but there are just 33.7% bulls vs. a historical 38.5%. Meanwhile, there are 32.3% bears, vs. an average of 30.5%. Again, the recent drop in the market may temporarily inflate the “bears” number, but it only went up 0.2% from the previous week (so not much).
Additionally, the Investors Intelligence Bull/Bear ratio remains above 3.0 (which implies excessive bullishness), but it’s not at a level that would imply “irrational exuberance.”
Point being, for a market that has been very impressively resilient throughout 2017, “faith” in the rally remains lacking (you’d expect to see people wildly bullish given how strong this market has been, but overall sentiment on stocks can still be described as “cautious” in aggregate).
Momentum Indicator #2: NYSE Advance/Decline Line. There are potential signs of a loss of momentum in this indicator. With the prior week’s sell-off, the NYSE Advance/Decline (A/D) line broke an uptrend in place since late-February 2016, and we view that as a potential warning sign.
Now, to be fair, we’ve seen this type of break twice before in the last two years. Once in October/November of 2016 (into the election), and once in March 2017.
The first break and recovery can be attributed to Trump’s surprise election victory igniting a rally in stocks (that’s not happening again this year). So, we are looking at the second break (in March) as a reference. That break lasted a little over 10 trading days before it bottomed, so we’ll watch for similar behavior from the A/D line now.
But, it’s important to note that the A/D line broke uptrends before the last two big pullbacks in stocks (August 2015, January 2016) so this is an indicator with a history of providing important warning signs, and we’re watching it closely.
Momentum Indicators #3 & #4: SOXX and FDN. As a refresher, tech broadly, and semiconductors and super-cap internet have once again been used as “long rentals” this year by money managers and investors.
What I mean by “long rentals” is that these ETFs are a cheap, easy way for money managers to add long exposure to client accounts in a rising market, giving themselves higher-beta exposure to tech and a growth segment of the market. Put simply, it’s an easy way to show clients you’re “long” the market at the end of the month after stocks have risen.
So, these sectors have led stocks higher as investors and money managers reluctantly (and begrudgingly) add long exposure to keep up with a buoyant tape.
But, as we’ve seen a few times since June (and most recently last week) that also leaves these sectors susceptible to sharp, intense declines as these “weak-handed” longs run for the exits during a pullback.
Point being, while the A/D line measures statistical momentum, these two sectors measure intangible momentum—the type of momentum you can observe only by watching the tape. And, recently, while both are still signaling uptrends, there has been a loss of positive momentum.
Semiconductors (SOXX) and super-cap internet (FDN) have led this market higher all year, but since June, one has lost real momentum. SOXX peaked in early June at $155 and two months later remains 5% off those highs. FDN, meanwhile, has traded better more recently, hitting a fresh high in late July.
Now, going forward, the June 30 low close of $140.20 is very important support. If that support level is broken, then it will imply that the trend in one of the leadership sectors of the market has turned lower, and that’s a problem for stocks more broadly. Turning to FDN, it hit fresh highs along with the market back in late July, but since then, we’ve seen that ETF come under some heavy selling pressure, especially the past couple of weeks.
FOMC Minutes Takeaway
The FOMC minutes resulted in a “dovish” reaction in currencies and bonds, but in reality, they didn’t reveal anything new.
The two big takeaways from Wednesday’s FOMC were 1) The Fed is united in reducing the balance sheet in September (which will be the start of the removal of additional accommodation) and 2) The Fed is divided on whether to hike rates in December because of low inflation. Neither of those takeaways should be surprising to anyone who has been paying attention.
The former (that the Fed is committed to reducing its balance sheet) was reaffirmed by the minutes yesterday, and while the market seems to be ignoring this event, I do want to remind everyone that the Fed will be reducing its Treasury holdings for the first time in a decade. That will, over time, have a “tightening” effect on the economy (although admittedly not at first).
The latter was where the market generated its “dovish” interpretation of the Fed minutes, but in reality the fact that “some” Fed members want to not hike rates again this year shouldn’t be a surprise. Bullard, Kashkari, Mester and others have voiced caution about further rate hikes in the past few weeks due to low inflation.
Conversely, Dudley, Williams and others have stressed very low unemployment and still-loosening financial conditions as reasons to continue with gradual rate increases. Otherwise, they risk getting behind a sudden upshot in inflation that forces them to raise rates very quickly. Point being, we know there is this divide, and it will be resolved in the coming months based on inflation data. If inflation data bottoms and heads higher, they’ll hike rates in December. If it doesn’t, they probably won’t. That’s no different than it was Wednesday at noon.
From a market standpoint, the reaction was “dovish” as the dollar and bond yields dropped, and stocks rallied modestly. But, the FOMC minutes should not be enough to elicit a material rally in stocks, nor should it be enough to push the dollar or bond yields to recent 2017 lows.
About the only notable takeaway from the minutes is that it’s likely anecdotally bullish for the “Stagnation” portfolio of FDN, XLV, IHF, IBB, IEMG, HEDJ/EZU and XLU/XLP—due in part to lower bond yields and a quiet calendar for the remainder of the month (outside of the Jackson Hole Fed meeting).
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