Progress Not Perfection
By John Stoltzfus,
Chief Investment Strategist
Déjà Vu All Over Again
We quote Yogi Berra as we caution investors not to jump to conclusions on Fed or trade policy
Stocks lost ground in a week that provided a degree of irony as the yield on the 10-year Treasury advanced to its highest levels since 2011. This sent stocks into a bit of a tizzy despite good economic news in the form of several data releases so far this month that in our opinion likely point toward continued improvement in the US economy. Instead markets were focused on news on the trade front (between the US and China) that has shown not much progress if in fact some deterioration.
Stock prices came under pressure as the yield on the 10-year US Treasury in the period of one week rose from 3.06% on September 29th to 3.23% last Friday. The jump in yield of over 17 bps rattled the equity markets stateside and abroad. The substantial jump in yield in such a relatively short time span would seem to us a bit overdone. A “glance under the hood” tells us indeed that this might be the case.
Strange bedfellows emerged amid the 11 sectors of the S&P 500 over and above the ruckus in the markets last week as the financial sector, which typically benefits from a steepening yield curve, advanced (as one would expect) as Treasury yields moved higher stateside while the utilities sector (considered by many investors to be a bond proxy and which tends to underperform when yields are on the rise) advanced as well tying with the energy sector to deliver last week’s best performances among the 11 sectors of the S&P 500. For the week the S&P 500 fell just under 1% as just four sectors managed to advance with the energy, utilities, financials and industrials sectors respectively posting gains of 1.9%, 1.9%, 1.5% and 0.8%.
With the utilities sector outperforming the broad market last week a strategist might well wonder just how shallow the conviction among market participants was about rising rates as stocks and bonds both sold off.
Perhaps last week’s action stateside was more of market participants finding a good hook to hang their proverbial hats on and find some reason to sell at the start of the fourth quarter (traditionally a time of rotation and rebalancing as the year moves toward conclusion) and a move ahead of third quarter earnings season which begins unofficially this Friday when some of the big banks release their earnings results.
“The Fed’s sensitivity this cycle would seem to provide more than a hint as to how the Fed moves from here in judging both strengths and risks to growth as it navigates its normalization of interest rates. ”
Also of interest in last week’s activity among the S&P 500 sectors was that the energy sector, which has been a sector laggard this year even as the price of oil has surged, rose along with several other sectors that have been out of favor this year.
Judging by the action among the sectors of the S&P 500, last week investors may have shown less conviction about the direction of interest rates but rather showed their hunger to buy four sectors (energy, utilities, financials and industrials) that have lagged their sector counterparts this year. We also believe that some investors took the opportunity to take profits in some of 2018’s leading sectors (information technology, consumer discretionary and health care), each of which are up in double digits (up respectively 16.8%, 14.2% and 14.2% year to date through last Friday’s close).
Fed Policy Gives Some the Jitters
In terms of the “worry du jour” that flashed across the screens last week about the potential for the Federal Reserve to get aggressive or “make a mistake,” we’d consider the Fed’s uncanny ability so far in the current Fed Funds hike cycle (which began in December of 2015 when they started raising rates) to remain sensitive to strengths and vulnerabilities in the US economy.
First, consider that in the current cycle the Fed has raised just eight times in a 33-month period versus in the prior cycle (end of June 2004-end of June 2006) when it raised rates at 17 consecutive meetings. Also, consider that in this cycle the Fed has raised the Fed Funds rate from a band of 0% to 0.25% to a current band that ranges from 2.00% to 2.25%. Last cycle it raised its benchmark rate from 1% to 5.25%, a considerably higher hurdle for businesses and consumers to traverse.
The Fed’s sensitivity this cycle would seem to us to provide more than a hint as to how the Fed moves from here in judging both strengths (from a recent solid brace of economic and corporate data) and risks to growth (ranging from the strength of the dollar and risks to trade from the tariff hikes between the US and China) among other factors as it navigates its normalization of interest rates.
Stocks stateside fell last week with the Dow Jones Industrial Average, the S&P 500, the S&P 400 (mid–caps), the Russell 2000 (small caps) and the NASDAQ Composite (some 40% weighted in technology or tech related names) respectively shedding 0.04%, 0.97%, 2.55%, 3.8% and 3.2%. For the year to date those same indices are respectively up 7%, 7.9%, 3.6%, 6.3% and 12.8%.
International stocks followed US stocks lower last week with the MSCI EAFE index (developed international markets ex-US and Canada), the MSCI Emerging Markets index, the MSCI Frontier markets and the MSCI All World Ex-US index losing 2.4%, 4.5%, 1.2% and 2.2%, respectively.
On a year-to-date basis, those same international indices have lost 6%, 13.6%, 16.3% and 5.9%, respectively. Mixed economic results, the effects of a strong US currency on dollar-denominated debt issued by foreign entities and the risk of a protracted trade war have produced downward pressure on many foreign markets, particularly those dependent on exports for much of their economic growth.
Treasury’s Mid Quarter Refunding this Week
In this holiday abridged week (Columbus Day in the US finds the US bond market closed on Monday) traders and investors will be paying close attention to the reception given to the US Treasury’s $230 billion of debt auctions from Tuesday through Thursday.
Tuesday, the Treasury is scheduled to bring to auction $156 billion of bills with maturities ranging from four weeks to one year.
Wednesday the Treasury is scheduled to offer $36 billion of three-year notes (the most since 2010) and $23 billion of 10- year notes.
Thursday the Treasury is scheduled to offer longer-term notes with $15 billion of 30-year bonds.
Higher yields as a result of last week’s turmoil in the bond market may attract significant attention from note and bond buyers this week and perhaps enough attention to bring about a rally as the week progresses.
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