Weekly Market Update – 28 May 2018 BMO

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WEEK IN REVIEW – 21 May to 25 June 2018

Equities finished the week a tick higher, unfazed by what seemed like a continuous flow of geopolitical headlines. Most of the news centered on U.S.-China trade relations and the U.S.-North Korea summit – which, as of Thursday, is “officially” canceled, but more on that later. The Dow settled the week up 0.2%, the S&P 500 added 0.3%, and the Nasdaq outperformed, jumping 1.1%.

The week began on a positive note following weekend comments from Treasury Secretary Steven Mnuchin, who said that a U.S.-China trade war has been put “on hold” while the two nations continue to try and work out their differences, and following news that last week’s trade talks ended with China agreeing to buy more goods from the U.S. in an effort to reduce its trade surplus. China followed up that pledge by announcing early on Tuesday that it will be cutting import tariffs on U.S. automobiles (to 15% from 25%) and on some U.S. auto parts (to 6% from 8-25%).

However, the upbeat vibes faded later on Tuesday when President Trump revealed that the White House has yet to reach a deal with Beijing to save struggling Chinese telecom company ZTE. The news didn’t sit well with investors, who had been expecting the president to use ZTE, which has been severely hurt by U.S. sanctions, as a bargaining chip in trade negotiations with Beijing. Reports on Friday indicated that President Trump and China have finally reached a tentative deal on ZTE, but by then the focus had largely shifted to the ongoing situation in North Korea.

President Trump canceled his June 12 summit with North Korean leader Kim Jong Un on Thursday, stating in an open letter to Mr. Kim that he felt the meeting was “inappropriate” based on the “tremendous anger and open hostility” displayed in a recent statement from a North Korean official directed at Vice President Mike Pence. However, the president has left open the possibility of meeting with Mr. Kim, saying on Friday that dialog with North Korea has reopened and that the summit could still happen.

In other political developments, President Trump officially signed the Dodd-Frank reform bill on Thursday, which rolled back regulations on small and medium-sized lenders put in place following the 2008 financial crisis. The president also added that the rollback may be extended to larger banks in the future. Separately, The Wall Street Journal reported that the Trump administration is considering import tariffs on automobiles that could be as high as 25%.

Investors received on Wednesday afternoon the FOMC minutes from the May meeting, which came in more dovish than expected, helping to fuel a late-session rally. The minutes pointed to a rate hike at the June meeting, as expected, and suggested that the Fed may not be as aggressive with its rate-hike path as many had previously thought. The latter takeaway stems from the acknowledgement in the minutes that officials would be content to let inflation briefly run above their 2.0% target.

Overseas, the prospect of a populist government coming to power in Italy weighed on Italian debt, pushing the yield on Italy’s 10-yr BTP higher by 25 basis points to 2.47%. A flight to safety pushed both German and U.S. debt higher – thereby reducing bond yields. The 10-yr German bund yield dropped 18 basis points to 0.40 this week, and the 10-yr U.S. Treasury note yield dropped 13 basis points to 2.93%. Investors also expressed concern over the ongoing situation in Spain following Friday reports that the country’s opposition party is looking to oust Prime Minister Rajoy.

Meanwhile, reports that Saudi Arabia and Russia will soon relax their crude oil supply constraints to compensate for any production fallout in Venezuela and Iran sent crude prices sharply lower this week. West Texas Intermediate crude futures hit a fresh three-and-a-half year high on Monday, but finished Friday 6.4% below that level at $67.91 per barrel. A rise in the U.S. dollar also didn’t help matters, making commodities, which are priced in U.S. dollars, more expensive for holders of foreign currencies. The U.S. Dollar Index jumped 0.6% this week to 94.13, its highest level since mid-November.

Back on Wall Street, retailers dominated the earnings front once again, with Lowe’s (LOW), TJX (TJX), Target (TGT), Ross Stores (ROST), Best Buy (BBY), AutoZone (AZO), Tiffany & Co(TIF), Gap (GPS), Kohl’s (KSS), Advance Auto (AAP), and Foot Locker (FL) reporting their quarterly results. The results come in mostly better-than-expected, but a few companies missed bottom-line estimates, including Lowe’s, Target, and Gap. The SPDR S&P Retail ETF (XRT) settled the week higher by 0.3%.

The S&P 500 sectors finished the week on a mostly higher note, with seven of the eleven settling in the green. The rate sensitive utilities space (+3.1%) led the charge, underpinned by the decline in Treasury yields, while the energy sector (-4.5%) was by far the weakest group, suffering from the drop in crude prices. The other sectors finished with weekly gains/losses of 2.0% or less.

(Excerpts from Briefing.com)

Friday Update: Stocks Slip Ahead of Memorial Day Weekend

The stock market ended Friday on a mostly lower note, but managed to keep in positive territory for the week. The S&P 500 declined 0.2% on Friday, closing the week higher by 0.3%. The Dow also dropped 0.2% on Friday, trimming its weekly gain to 0.2%, while the Nasdaq ticked up 0.1%, extending its weekly advance to an impressive 1.1%.

North Korea-U.S. relations were in focus once again on Friday after a North Korean official responded with a conciliatory tone to President Trump’s Thursday decision to cancel his scheduled summit with North Korean leader Kim Jong Un, saying that North Korea is still willing to meet with the United States. President Trump later revealed that communication has reopened with North Korea, adding that the summit could still happen — possibly even on the originally scheduled date of June 12.

Separately, the Trump administration has reportedly reached a deal with Beijing to save struggling Chinese telecom company ZTE that involves ZTE paying a fine, hiring compliance officers, and changing its management. There were also reports that, in connection with the ZTE deal, the U.S. is pushing for approval of the proposed Qualcomm (QCOM)/NXP Semi (NXPI) merger. The merger has been approved by eight of the nine required global regulators, with Chinese approval still pending.

Energy shares dropped sharply on Friday, pushing the S&P 500’s energy sector lower by 2.6%. The energy sell off coincided with a tumble in crude oil futures, which further retreated from Monday’s three-and-a-half year high following reports that Saudi Arabia and Russia are thinking about reducing supply constraints to make up for any production fallout in Iran and Venezuela. West Texas Intermediate crude futures lost 4.0% on Friday, settling at $67.91 per barrel, marking a fresh three-week low.

Outside of energy, most S&P 500 groups finished within 0.4% of their flat lines. Within the consumer discretionary space (+0.2%), retailers were all over the place following another batch of earnings reports. Ross Stores (ROST) and Gap (GPS) dropped 6.8% and 14.6%, respectively, after missing earnings estimates for the first quarter, while Foot Locker (FL) surged 20.2% after beating both top and bottom line estimates.

In the bond market, U.S. Treasuries extended their weekly gains, sending yields lower across the curve, thanks to some inflows from European investors, who sought some security from continued political uncertainty within the region following reports that the main opposition party in Spain is seeking to remove Prime Minister Mariano Rajoy. The yield on the benchmark 10-yr Treasury note finished Friday five basis points lower at 2.93%, closing the week with a loss of 13 basis points.

Elsewhere, the U.S. Dollar Index advanced 0.4% on Friday to 94.13, marking its best close since mid-November.

Reviewing Friday’s economic data, which was limited to April Durable Orders and the final reading of the University of Michigan Consumer Sentiment Index for May:

U.S. markets will be closed on Monday in observance of Memorial Day.

Market Internals – Friday 25 May

Dollar: Dollar Index Remains Resilient

The U.S. Dollar Index was up 0.5% at 94.20, for its third advance of the week. The Dollar Index took a step back on Thursday, and continued inching lower in overnight trade. The Index marked a session low around 6:30 ET on Friday, but bounced back swiftly, rising to a fresh swing high in mid-morning trade. The Dollar Index has climbed 0.6% since last Friday, looking to record its fifth weekly advance over the past six weeks.

Bonds: Rebound Extended

U.S. Treasuries ended the week on a higher note with the belly of the curve showing relative strength. The Friday affair was fairly quiet, as Treasuries started the day with modest gains, hitting highs during the opening 90 minutes of the cash session. However, today’s advance represented the third consecutive day of solid gains amid growing political uncertainty in Europe. In Italy, Prime Minister-designate Giuseppe Conte has yet to form a cabinet with reports pointing to uncertainty whether euroskeptic Paolo Savona will be named economy minister. Meanwhile in Spain, opposition parties have taken aim at Prime Minister Mariano Rajoy after 29 people related to Mr. Rajoy’s party were convicted of corruption-related offenses on Thursday. The developments underscored the relative attractiveness of U.S. Treasuries in the face of aggressive net short positioning. This week’s rally lifted the 10-yr note and the 30-yr bond to their best levels since late April while the 30-yr yield settled just below its 50-day moving average (3.10%).

The yield curve flattened last week with the 10-year maturity falling 14 basis points as the 2-year retreated by only 6 basis points. The spread between the 5s10s narrowed to 17bps from 18bps the previous week. 

Commodities 

The Bloomberg Commodity Index closed at 91.51, higher than 90.41 the previous week.

Crude: Brent-WTI spread widens to $8.56 as   

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 5.8 mln barrels from the previous week. At 438.1 mln barrels, U.S. crude oil inventories are in the lower half of the average range for this time of year. Total motor gasoline inventories increased by 1.9 mln barrels last week, and are in the upper half of the average range. Finished gasoline and blending components inventories increased last week. Distillate fuel inventories decreased by 1.0 mln barrels last week and are in the lower half of the average range for this time of year. Propane/propylene inventories increased by 0.7 mln barrels last week, and are in the lower half of the average range. Total commercial petroleum inventories increased by 6.7 mln barrels last week.

Natural gas inventory showed a build of 91 bcf vs a build of 106 bcf in the prior week. Working gas in storage was 1,629 Bcf as of Friday, May 18, 2018, according to EIA estimates. This represents a net increase of 91 Bcf from the previous week. Stocks were 804 Bcf less than last year at this time and 499 Bcf below the five-year average of 2,128 Bcf. At 1,629 Bcf, total working gas is within the five-year historical range.

Baker Hughes total U.S. rig count increased by 13 to 1059 following last week’s increase of 1.

Metals: Gains led by Precious

Agriculture: Grains Rise

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THE WEEK AHEAD

The coming week is a shortened week in the U.S. for Memorial Day and in Singapore, Malaysia and Indonesia for Vesak/Wesak/Waisak Day.

It is interesting to note that although the first trading day of June (Friday 01 June) tends to be bullish, when it goes down, it can be rather tragic as in 2008, 2009 and 2010 with an average -1.1% loss and in 2011 and 2012 with an average loss of -2.2%.

The twenty-second week of 2018 (wk22 – 28 May to 01 June) is a shortened week as Monday is a holiday:

Key Economic Dates

It will be a shortened but busy week. The US will publish the jobs report, the second estimate of GDP growth, personal income and spending, PCE prices and pending home sales. Elsewhere: China official PMIs, Japan unemployment, Euro Area inflation and unemployment, and GDP growth for India, Brazil and Canada will also be in the spotlight.

Mon 28 May

Tue 29 May

Wed 30 May

Thu 31 May

Fri 01 June

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THE MONTH AHEAD

June is the final month of Quarter Two and the last of the “best eight months” on NASDAQ. The month is known for its unpredictable nature.

June 2018 has twenty-one (21) trading sessions with no public holidays. June starts well but swings down and up and down from week to week for the rest of the month.

June Trivia

SUMMARY

So as May draws to a close with only three sessions remaining, the odds of a “Sell-In-May” is highly unlikely. After 21 weeks of trading, the Dow Jones Industrial Average is barely up by +0.1% YTD while the S&P500 has a bit more at +1.8% YTD. Tech strength stays unabated with the Nasdaq Composite gaining +7.7% YTD, the best gains amongst all the benchmarks and sector indices.

As of Friday’s close, the DOW is only 774 points (3.2%) above its 200DSMA. June’s seasonal statistics on the DOW and S&P500 doesn’t seem to suggest that the benchmarks could fall below that critical average before the mid-year. There is also the Index Addition amongst the Russells along with the possibility of Portfolio Pumping towards the end of June that usually rallies the broader market. Given the current state of the US economy, there is still no real reason to worry about any recessionary threat that could tank/crash the market in the near term.

The real worry is that if June doesn’t correct and instead rallies higher, valuations are going to get crazier than they have already been. According to the Shiller PE Ratio, in spite of the correction since February, valuations still remain very lofty at 32.34 when the long term median has been only half of that.

Such lofty valuations do not gel well with the US growth at 2.3% (when its long term median has been around 3.18%) amidst rising inflation at  2.5 percent in April 2018, up from 2.4 percent in March 2018.

This could have a very telling effect on earnings when Q3 earnings season comes round in July. But that’s a story for another day. For now, I’ll be watching the last three days of May for the unlikely last-minute correction as well as effect that falling oil prices and a rising dollar may have on the broader market.

Happy Hunting!

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