Weekly Market Update – 18 June 2018 BMO

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WEEK IN REVIEW – 11 to 15 June 2018 :
Little Changed Following Headline-Heavy Week

There was a steady stream of noteworthy news this week, but none of the headlines moved the S&P 500 in a significant way. The benchmark index ended the week almost exactly flat, adding less than one point. The tech-heavy Nasdaq outperformed, adding 1.3%, while the Dow lagged, losing 0.9%.

This week’s story really began over the weekend when the annual Group of Seven meeting, which was held in Quebec, ended on an uncharacteristically contentious note. President Trump was prepared to sign the customary joint statement, but changed his mind following what the White House deemed as “inappropriate” comments from Canadian Prime Minister Justin Trudeau.

The world then turned its attention to Singapore, where President Trump met with North Korean leader Kim Jong Un on Tuesday in a historic summit that marked the first ever meeting between a sitting U.S. president and a North Korean leader. The meeting ended with a joint statement in which North Korea reaffirmed its commitment to completely denuclearize and the U.S. promised “security guarantees” – including the suspension of military exercises on the Korean Peninsula. The two nations will engage in follow-up negations to work out the specific details.

Monetary policy took center stage midweek when the U.S. Federal Reserve released its latest policy directive. The Fed decided to raise interest rates for the second time this year, increasing the fed funds target range by a quarter point to 1.75% to 2.00%, and upped its interest-rate forecast to include a total of four rate increases this year – up from three in March. The market had expected the rate hike, but the updated forecast took some by surprise.

Overseas, the European Central Bank released its latest policy directive on Thursday. As expected, the ECB left its key policy rate unchanged and announced a plan to end its asset purchase program. The ECB in September will cut its monthly purchases in half, from EUR30 billion to EUR15 billion, and then end purchases altogether three months later – although it will continue to reinvest the principal from maturing securities. As for interest rates, the ECB said they will remain at their present levels “at least through the summer of 2019.” That statement was credited with sending the euro down more than 1.0% against the U.S. dollar.

The Bank of Japan also conducted a policy meeting this week, but made no changes to its key interest rate. However, the BoJ did downgrade its view on inflation, further highlighting the difference between the BoJ, which is struggling to end its crisis-era stimulus, and the Fed, which continues to progress on a path to normalization.

Back in the States, media names were in focus after a federal judge on Tuesday ruled in favor of AT&T (T) in its drawn-out legal battle with the Justice Department. The ruling allowed AT&T to move forward with its acquisition of Time Warner (TWX), which it closed on Thursday, and set the stage for more merger activity in the future. Comcast (CMCSA), for instance, outdid Disney’s(DIS) all-stock bid for the bulk of 21st Century Fox’s (FOXA) assets following the ruling, offering $65 billion in cash.

In politics, trade war fears were reignited on Friday after President Trump confirmed that he’s approved a 25% tariff on $50 billion worth of Chinese goods. China responded swiftly, announcing that it’ll impose a 25% tariff on $34 billion worth of U.S. goods on July 6, the same day the U.S. tariffs are scheduled to take effect.

(Excerpts from Briefing.com)

Friday Update: Trade War Fears Re-Enter the Mix

Trade war fears weighed at the start of Friday’s session, but stocks rebounded intraday, leaving the major averages just modestly lower. The S&P 500 was down as much as 0.7%, but ended with a loss of just 0.1%. The Nasdaq slipped 0.2%, retreating from Thursday’s record high, while the Dow lost 0.3%.

President Trump confirmed before the open that he’s approved a 25% tariff on $50 billion worth of Chinese goods and warned of additional tariffs should China retaliate. Unfazed by the threat, Beijing announced that it will impose a 25% tariff on $34 billion worth of U.S. goods starting on July 6, which is when the U.S. plans to impose its tariffs. Beijing also noted that a tariff on another $16 billion worth of U.S. goods could be imposed at a later date and said any previously negotiated agreements, including China’s offer to buy nearly $70 billion of U.S. goods, will be invalid.

The S&P 500 sectors ended Friday pretty evenly split between green and red. Five groups advanced, led by the countercyclical consumer staples (+1.3%), utilities (+0.7%), and telecom services (+1.2%) spaces, while six groups declined. The energy space (-2.1%) finished at the back of the pack by a wide margin as crude prices tumbled.

West Texas Intermediate crude futures dropped 2.7% to $65.06 per barrel, their worst close since hitting a two-month low on June 6. Crude traders have their eyes on next week’s OPEC/non-OPEC meeting where oil producers are expected to raise their production targets in order to combat falling output from Venezuela and Iran.

In addition to energy, the top-weighted technology sector (-0.5%) also underperformed, with mega caps Apple (AAPL) and Microsoft (MSFT) dropping 1.0% and 1.3%, respectively. Adobe Systems (ADBE) also struggled, losing 2.4%, despite beating quarterly earnings estimates.

Elsewhere, AT&T (T) completed its acquisition of Time Warner after the Department of Justice decided against applying for a delay of Tuesday’s ruling, and shares of General Motors (GM) spiked intraday following a Bloomberg report that the company is having early discussions with banks about strategic options for its self-driving car unit Cruise Automation.

U.S. Treasuries were fairly volatile on Friday, with the yield on the 10-yr Treasury note drifting between 2.89% and 2.94%. The benchmark yield eventually settled two basis points below its Thursday close at 2.92%, while the yield on the 2-yr Treasury note lost three basis points, dropping to 2.55%.

Overseas, the Bank of Japan kept its key interest rate unchanged, as expected, but downgraded its view on inflation.

Reviewing Friday’s economic data, which included the Industrial Production and Capacity Utilization report for May, the preliminary reading of the University of Michigan Consumer Sentiment Index for June, and the Empire Manufacturing report for June:

Market Internals – Friday 15 June

Dollar: Dollar Index Holds its Ground

The U.S. Dollar Index was little changed at 94.80 after spending Friday inside a narrow range. The Dollar Index capped a daylong climb with its best settlement of the year while the session had been a lot more mixed, leaving the Index on track to gain 1.3% for the week. The greenback has retreated modestly against the euro and the pound, but it has continued rising against the Australian dollar and the Canadian dollar. The dollar’s performance against emerging market currencies has been mixed, but it is worth noting that the Argentine peso has slid to a fresh record low after surrendering a short-lived gain that was forged after former Wall Street trader Luis Caputo replaced Governor Federico Sturzenegger at the Central Bank of Argentina.

Bonds: Busy Week Capped With Gains

U.S. Treasuries finished a jam-packed week with gains across the curve. The trading day began amid reports that President Trump would call for the imposition of a 25.0% tariff on $50 billion worth of goods imported from China. This was met with a swift response, as Chinese officials called for a 25.0% tariff on $34 billion worth of imports from the United States to be imposed on July 6th while a tariff on another $16 billion worth of goods could be imposed at a later time.

Treasuries built on their opening gains through the first two hours of Friday’s session, but the advance found resistance near last week’s high. The market backtracked in midday action, but the selling abated once Treasuries approached their opening levels. The yield curve faced intraday pressure, but the 2s10s spread returned to unchanged at 37 bps by day’s end while the 2s30s spread expanded by a basis point to 50 bps.

The yield curve flattened as the 2 and 5 year yields advanced while the 10 and 30 year yields retreated for the week. The spread between the 5s10s narrowed to only 12 bps from 16bps the previous week while the 10s30s narrowed to 13bps from 14bps the previous week. 

 Commodities 

The Bloomberg Commodity Index settled at 89.22, lower than 90.98 the previous week as Metals, Energy and Grains continued their slides for another week.

Crude: Energy gets hit, WTI settles at $65.06/barrel, Brent $73.44/barrel

The spread between WTI and Brent narrowed to $8.38 from $10.70 the previous week.

EIA petroleum data for the week ended June 8

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) decreased by 4.1 mln barrels from the previous week. At 432.4 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 decreased by 2.3 mln barrels last week and are in the upper half of the average range. Both finished gasoline and blending components inventories decreased last week. Distillate fuel inventories decreased by 2.1 mln barrels last week and are in the lower half of the average range for this time of year. Propane/propylene inventories increased by 3.7 mln barrels last week and are in the lower half of the average range. Total commercial petroleum inventories decreased by 1.8 mln barrels last week.

Natural gas inventory showed a build of 96 bcf vs a build of 92 bcf in the prior week. Working gas in storage was 1,913 Bcf as of Friday, June 8, 2018, according to EIA estimates. This represents a net increase of 96 Bcf from the previous week. Stocks were 785 Bcf less than last year at this time and 507 Bcf below the five-year average of 2,420 Bcf. At 1,913 Bcf, total working gas is within the five-year historical range.

Baker Hughes total U.S. rig count decreased by 3 to 1059 following last week’s increase of 2.

Metals: Fall Back

Agriculture: Grains lower for another week

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THE WEEK AHEAD

Week 25 tends to start a little bullish but becomes bearish midweek and ends very bearish over our 10 and 15 year models. The 5-year average has been mildly bullish.

Benchmarks (21 year average) for wk25:

Key Economic Dates

Week 25

The US will publish existing home sales, building permits and housing starts, and flash Markit PMIs. Elsewhere, the BoE will decide on monetary policy. Other important releases include: UK CBI factory orders; Eurozone flash Markit PMIs; and Japan inflation, trade balance and Nikkei Manufacturing PMI.

Mon 18 June

Tue 19 June

Wed 20 June

Thu 21 June

Fri 22 June

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SUMMARY

Is that a new high on the benchmarks with the possibility of a new low? If it is, this is a nice gradient for an uptrend that breaks the parabolic nature of the last two years. If this persists through the next month, I might be inclined to think that we’ve begun the next leg up.

One glaring observation for the past week is the divergence between the benchmarks especially between the DJIA and the Dow Transports;

I’ll be watching for more of these price-to-price divergences in the coming sessions especially when the variances have been as wild as the past week.

In the meantime, the hikes keep coming and will continue to keep coming in spite of earlier speculations. This usually gives the market more upside legs.

To learn more about the relationship between the 10yr Yield, the FFR and the Market, read this article: Riding the Rate (The Fed Funds Rate, The Market & 2016

The Fed’s projections for the coming years also hint at more market upside as rates are expected to hit more than 3% by 2020.

Trade Wars aside, I reckon the rest of the month will be seeing higher highs. I am still cautious but less so. However, there isn’t a lot to choose from during this period to be reliably long.

As the end of June closes in, don’t forget the habitual (and illegal) Portfolio Pumping that could happen – given the year so far hasn’t been hugely profitable for the funds – as well as the Index Addition changes amongst the mid and small caps as the Russels swop around their components.

Guess I’ll stick with the indices and oil for now.

Happy Hunting!

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