As BCA so eloquently stated, ‘bond bears just mauled goldilocks.’ A disparity between the financial markets view of ‘high’ rates and what rates the economy may be able to withstand resulted in quite a ride for financial markets last week. A disappointing U.S. Treasury auction Wednesday and rising Italian yields sent global equity volatility sharply higher mid-week. Naturally, higher valuation and momentum areas of the market were the focal point of the volatility spike which was the biggest we’ve seen since the market correction in early February. While trade negotiations will continue to make headlines, we feel Chinese growth and central bank monetary policies are the key drivers to monitor closely. Continued indigestion/market consolidation may continue over the coming weeks, but we do not feel rates are yet in restrictive territory. Until we reach that point, maintaining a constructive posture with regard to risk assets seems prudent.
- Wednesday’s drop in the S&P 500 was only the 98th time it has fallen over 3% since 1952 - less than 0.57% of trading all days in that timeframe. Looking at subsequent market performance, it strongly suggests a ‘stay the course’ mindset.
- From a technical perspective, the S&P 500 quickly reached oversold territory. The percentage of stocks trading above their 50 dma dropped from approximately 70% to an oversold 10% level in a handful of trading days and the S&P closed a ridiculous 3.7 standard deviations below its 50 dma. It traveled to and through its 200 dma on Thursday before regaining it by Fridays close.
- U.S. small caps have consolidated quickly. The Russell 2000 entered market correction territory and the average stock in the S&P 600 is down 20% from their 52-week highs.
- The lumpy auction of $23B in 10-year notes produced a yield of 3.225% and a $36B auction of 3-year notes went off at 2.989%, the highest yield since May 2007. Yields on both issues settled meaningfully by the end of the week.
- FactSet consensus earnings estimates calling for 3Q growth of 19.2% and S&P 500 index price appreciation of 10.5% over the coming 12 months. The tax bill sugar high seems to be wearing off - analyst earnings expectations have become increasingly pessimistic (revision spread of -8.1%) - a good sign for S&P 500 performance.
- China has responded to lagging growth with tax cuts, lowering required reserves by 1%, reducing interest rates, and a significant increase in state debt issuance aimed at infrastructure initiatives.
- Worries about Italian debt sustainability resulted in more clashing with EU over their budget last week. Italian borrowing costs hit a 4yr high. The PM said he won’t implement EU prescribed austerity and described EU officials as “enemies of Europe.”
- Of note is that while average hourly earnings ticked down to 2.75% yoy, this was largely due to base effect. We’ve had m/m wage growth of .3% for three straight months which, if that pace continues, will take yoy wage growth to 3.2% by year end.
- Iranian sanctions are real. Oil shipments from Iran fell to 1.1mbpd, down from over 2.5mbpd in April.
Economic Release Highlights
- September PPI slipped 0.2% to 2.6%, a pretty benign report. Transportation costs +5.9% yoy due to capacity constraints was the only notable price pressure.
- September CPI came in more subdued than expected at 2.3% headline and 2.2% core levels. The report confirmed that wage increases have yet to spill over into higher prices.
- Preliminary October consumer sentiment slipped slightly to a still robust 99.0 level. Confidence in the government’s economic policies is at a 15-year high and inflation expectations edged slightly higher.
- Wholesale sales inventories suggest that the pace of inventory accumulation is accelerating - a constructive observation that may push Q3 growth close to 4%.