(Tuesday Market Open) If you feel like celebrating after two sessions of big stock market gains, it might be better to keep the cake in the cupboard at least for now. While it’s tempting to say that the wicked witch of falling bond yields is dead, a lot of signs continue to indicate we might not be out of those lion-infested woods.
For an example of the caution still out there, consider the Financial sector. It’s trading at a price-to-earnings (P/E) ratio well below its historic average even though the S&P 500 (SPX) is only about 3% below its all time high. Some of the major bank stocks like Goldman Sachs (NYSE:GS), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) did post 1% or better gains on Monday.
Not that these aren’t nice moves, but they’re not responding the way you might expect if people were really feeling secure about getting past the poppy patch of possible yield declines. The group’s low P/E, which is at about 11.5 vs. an average of around 15.5 over the last two decades, could show that people remain nervous going forward.
The other thing to consider is that one reason bond prices fell and yields rose Monday was news of a potential economic stimulus by Germany. Some investors appeared to take this as a positive development, hoping it might stir a revival in the wilting European economy. However, what happens if Germany decides to do a stimulus? It probably buys fixed income, and that means rates possibly moving lower.
With the German 10-year bund yield already near all-time lows at around negative 0.6%, any new bond buying there could put extra pressure on bond yields here, which are low but way above Germany’s. This is a world economy, and nothing happens in a vacuum. That’s why it might be worth closely watching for more news on what, if anything, Germany intends to do, because it could have an impact here.
It’s a strange market, and many people remain nervous. There’s probably a lot more to come.
Yesterday’s rally did basically erase all of last week’s losses, which is pretty amazing in and of itself. However, the rally was arguably more about bonds being down than stocks being up, though the Huawei extension news also might have helped.
Other than that, there wasn’t a lot of economic or earnings news necessarily driving equities higher—just relief that bonds took a ride lower. It’s unclear how much longer stocks can rally simply on bad days for bonds. What remains to be seen is whether the two-session losses in bonds just reflected some profit-taking or if it’s the start of a new pattern.
From a technical standpoint, the SPX could run into some resistance at a range between 2935-2940. It’s been difficult for the SPX to push through that lately, and it corresponds closely with this month’s highs and also with highs posted last September.
One positive take-away from Monday was continued gains in the cyclical sectors, including Energy and Technology. The weakest sector of the day was Utilities, traditionally one people move into when they feel defensive. This could be another pattern to consider watching as the week advances.
Besides all the retail earnings, this week’s Jackson Hole symposium for the Fed looms large. Fed Chairman Jerome Powell’s speech is Friday morning, and sometimes in the past we’ve seen Fed leaders use this occasion to make pronouncements about their outlook and potential strategy.
While the CME Group’s Fed funds futures market now indicates a 91% likelihood of a 25-basis point September interest rate slice, there’s a “whisper number” on the Street suggesting some investors want to see a 50-basis point cut. It’s likely that Powell’s words on Friday will be carefully considered to see if he hints at a more dramatic drop than the futures market indicates.
The conundrum for the Fed could be if it sees decent U.S. economic data over the next month even as yields in Europe continue to sink. While the Fed probably doesn’t want U.S. rates to be too out of line with the rest of the world, it also has to consider what’s right for the U.S. economy. Powell and company are certainly in a rough spot.
Before Powell’s speech later in the week, we get Fed minutes tomorrow afternoon from the last meeting. One thing Powell said after that meeting’s 25-basis point cut was that he saw it as a “mid-cycle adjustment,” and many investors interpreted that as a hint that Powell might be less dovish than they’d thought. He did walk back those words later in his press conference, but the minutes could provide more insight into where that statement might have originated from.
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FIGURE 1: COMEBACK TRAIL? Two of the most battered sectors over the last month—Energy (candlestick) and Financials (purple line)—started to show some life the last couple of sessions. This is a pattern that might bear watching to see if recession fears that dogged both sectors continue to retreat. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Follow That Spread! For a while, the three-month to 10-year yield spread was the one to watch, but that was earlier this year. Now the main one to keep an eye on is the one between the 10-year and the two-year that briefly inverted last week. By early this week, the 10-year was a solid 15 basis points above the two-year—thanks in part to some better economic data and declining futures market odds of a near-term 50-basis point interest rate cut.
Still, it’s down from a 75-basis point spread a couple years ago and still probably too close for the bulls’ comfort. For short-term traders, any sign of that spread narrowing is something to consider thinking about carefully, because we all saw what can happen when the two converge (800-point one-day drop in the Dow Jones Industrial Average last week). The market’s near-term performance hinges on many factors, but don’t count this one out as a major one.
Catching a Copper: If you look at a year-to-date chart of the S&P 500 (SPX), things seem pretty nice. The problem comes when you see a one-year chart and it becomes clear that the market has barely moved since last August, up less than 3% despite all the wild rallies and sell-offs. Another important economic monitor tells the same tale year-over-year. It’s copper, the key industrial metal that’s often seen as a barometer for global economic health because it’s used in so many different products. Recently, copper futures traded at $2.60 a pound, compared with around $2.66 a pound one year ago.
Copper had its own wild ride earlier this year, challenging $3 twice before turning back to more than two-year lows recently as the trade war flared up. Now some analysts think copper has a chance to rebound thanks to demand fundamentals, Barron’s reported. This is in part because of the growing popularity of electric cars, which could increase copper use over the next 10 years. Also, market dynamics suggest a copper rally, Barron’s reported, noting that investor positions in the futures market are heavily net-short.
Dividend Spark? In this shaky economic environment, a lot of investors seem to be hunting for yield. That might be reflected in decent showings lately from some big dividend stocks like AT&T (NYSE:T) and Verizon (NYSE:VZ). The Ts and VZs of the world have high yields and appear to be catching a wave. At the same time, Energy is the worst-performing sector over the last month by far, despite many big players there offering yields of 2.5% to 4% almost across the board. The problem might not be the yields or even the companies offering them. Instead, it’s probably weakness in crude oil. If crude could find a way to get back above $60 a barrel, maybe we’d see some Energy stocks start to get a bid, but until then, investors appear to be having a tough time considering these as safe places to park their money.
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