Market Strategy Radar Screen Weekly - April 11, 2016

If You Can’t Have the One You Love…

“Risk on” is followed by “risk off,” driven by a market seeking a catalyst for next move

The VIX, a gauge of market volatility (see page 5), jumped 17.3% last week as the S&P 500, the S&P 400 (mid-caps) and the Russell 2000 (small-caps) slipped -1.2%, -1.7% and -1.8% respectively.

From our perch on the market radar screen it looks as if markets are doing about what they should be doing at this juncture: taking a trim (i.e., profit taking), giving back some of the market’s earlier rally, and taking a breather for rotation and repositioning.

To us it seems analogous to drivers and passengers taking a break on a long journey, getting out of the vehicle for a healthy stretch en route to a destination somewhere ahead on the map.

For those with a sartorial bent we’d suggest the analogy of getting a trim or haircut in advance of a pending event.

The timing of the recent waft of negativity, which saw theS&P 500 end last week at 2047.60 or 1.2% off its 2016 high of 2072.78 reached on April 1, worked almost like clockwork as time grew closer to the unofficial start of Q1 earnings season when Alcoa (AA) reports first- quarter results (after the market’s close today) and optimism turned to skepticism about growth linked to the economy, revenues and earnings.

Such market action seems to us to have become fairly common on and around quarterly earnings seasons, Fed minutes releases, and in response to remarks by Fed officials in what has become termed as periods of “Fed-speak.” (This week four Fed regional presidents are scheduled to appear at events around the country.)

Focus on the Bond Market

In bond land interest rates have moved lower this year as bond market participants bid bond prices higher after the Fed Chair’s remarks in the week prior to last and after investors’ perusal of the FOMC minutes released last week.

As markets have sought and found well-worn catalysts to gnarl and gnaw on once again over the last week, markets switched from “risk on” to “risk off” and back to “risk on” with varying degrees of fleeting conviction.

By last Friday the:

• 2-year Treasury yield stood at 0.697%, down from 1.05% at the start of the year;

• 10-year Treasury yield stood at 1.72%, down from 2.27% at the start of the year;

• 30-year Treasury yield stood at 2.55%, down from 3.02% at the start of the year. 

Ten- and Two-Year Treasury Note Yields YTD

Source: Bloomberg, OAM Research.

As much as some investors want rates to rise, we’re prodded to suggest that the markets can’t merely wish interest rates higher.

While interest rates can move higher on projections and expectations of inflation, they won’t stick higher without some degree of inflation.We recall 2013 when the yield on the 10-year Treasury advanced from a low of 1.62% on May 2^nd of that year to a high of 3.03% on December 31^st on market participants’ projections of what would be the outcome of the process of Fed tapering that then Fed Chairman Ben Bernanke had introduced as a concept in May of that year.

Thirty- and Ten-Year US Treasury Yields YTD

Source: Bloomberg, OAM Research.

While higher commodity prices can provide a whiff of inflation, higher prices are unlikely to stick if wages don’t or can’t rise to make higher prices affordable for the consumer and inflation sustainable.

Investors stateside face a busy week ahead with:

• Earnings results this week from a number of bellwether stocks belonging to cyclical sectors that include: materials, financials, industrials and consumer discretionary.

• Economic data including:

Advance retail sales (Wednesday); The producer price index (Wednesday); Business inventory revisions (Wednesday); The Fed’s Beige Book (Wednesday); The CPI (Thursday); Personal (weekly) earnings growth (Thursday); Along with data on Friday that includes manufacturing, consumer sentiment, industrial production and capacity utilization along with the Treasury’s TIC data (a measure of foreign investment flows into and out of US assets).

From a global perspective the IMF issues its World Economic Outlook on Tuesday followed by a briefing on the Global Policy Agenda on Thursday.

Earnings Season Preview

FactSet reports that for Q1 S&P 500 earnings season analysts expect earnings to drop -9.1%.

As recently as December 31^st of last year expectations for Q1 were for a 0.7% increase in earnings.

The Energy sector has recorded the largest decrease in earnings expectations for the quarter to -103.8% from an earlier projection of -43.8%.

For a fourth consecutive earnings season the Energy sector is expected to drag the overall earnings of the benchmark lower.

Ahead of Q1 earnings season, all ten sectors have seen declines in earnings growth expectations to date.

While Alcoa unofficially opens earnings season today, 22 companies thus far have reported Q1 results. FactSet shows that 19 of those companies have reported earnings above the mean estimate while 14 have reported sales above the mean estimate.

For yet another quarter analysts’ downward revisions to estimates ahead of earnings season may be deep enough once again to make the earnings season’s bark is worse than its bite.

Stay tuned.

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