Weekly Market Update – 09 July 2018 BMO

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WEEK IN REVIEW – 02 to 06 July 2018 :
Independence Day Bring Gains For The Week

It was an abbreviated week of trading due to the Fourth of July holiday, yet there were plenty of fireworks for the bulls who enjoyed a winning week for the major indices.

The bullish bias was remarkable in that concerns about protectionist trade measures were discussed throughout the week.  Those concerns did not derail the stock market, yet they did not go unnoticed.

Some of this week’s best-performing sectors were the defensive-oriented health care (+3.1%), utilities (+2.4%), and telecom services (+2.2%) sectors. Meanwhile, the yield on the benchmark 10-yr note dropped three basis points to 2.82%, which gave a lift to the real estate sector (+1.8%).

By and large, though, it was a risk-on week in the stock market, which moved up on the back of gains in every sector but the energy sector (-0.3%). 

The latter moved in tandem with oil prices, which dropped 0.5% to $73.77/bbl, pressured by a bearish inventory report from the Department of Energy and assumptions that Saudi Arabia will tap into its spare capacity to maintain stability in the oil market.

The information technology sector (+2.3%), supported by the usual mega-cap suspects, was a standout yet again, bringing its year-to-date gain to 12.7%.  Facebook (FB) for its part increased 4.6% for the week, with the entirety of its gain coming over the last two trading sessions.

Those last two trading sessions were governed by insouciant trading behavior, as the major indices advanced resolutely in the face of the FOMC Minutes highlighting how business contacts in some districts were scaling back, or postponing, capital spending plans as a result of the uncertainty over trade policy and the U.S. and China pressing ahead with the implementation of tariffs on $34 billion worth of imported goods from each other.

There was no uncertainty on Friday following the release of the June employment report.  Market participants seemingly rejoiced in the understanding that the report once again had a Goldilocks hue to it, featuring solid nonfarm payrolls growth (+213,000) and a subdued 2.7% year-over-year gain in average hourly earnings that kept inflation worries, and aggressive rate-hike worries, at bay.

That economic report overshadowed the gloomy trade developments, which also included a contention by President Trump that the U.S. could possibly levy tariffs on more than $500 billion of Chinese goods if necessary.   The stock market made note of the remark, yet it was not unnerved by it.

The US. Dollar Index settled the week 0.7% lower at 94.01 while the CBOE Volatility Index plunged 16.9% to 13.37, underscoring a lack of hedging interest to protect for near-term downside risk.  The entirety of the decline in the CBOE Volatility Index came over the last two trading days of the shortened week.

Not surprisingly, trading volume was on the light side this week as many participants took vacation.

(Excerpts from Briefing.com)

Friday: Market Trades Trade Concerns for Labor Market Relief

Apparently, a trade war started on Friday – or so it was said – yet the stock market acted as if there was a daisy stuck in the barrel of every trade threat.  For the second day in a row, the stock market ignored the trade conflict between the U.S. and China (and other countries for that matter) and rallied around a pleasing employment report for June.

It was clear to see in the futures market this morning how the employment report was the inflection point for a shift in trading sentiment.  Prior to its release at 8:30 a.m. ET, the S&P futures were down as many as seven points and signalling a modestly lower start for the broader market.

Following the release, they turned positive, and although the open to today’s session was a bit tentative, the bulls soon took command of today’s tape, ceding some ground only in a profit-taking retreat in the last 30 minutes of trading.

The catalyst for the upside bias was the recognition that the June employment report had a familiar Goldilocks hue to it.  Specifically, it featured solid nonfarm payrolls growth (+213,000) and a subdued 2.7% year-over-year gain in average hourly earnings that kept inflation worries, and aggressive rate-hike worries, at bay.

The stock market wasn’t the only beneficiary of that fairy-tale theme.  The Treasury market also enjoyed the not-too-hot-not-too-cold narrative.

The 2-yr note yield, which is more sensitive to changes in the fed funds rate, fell three basis points to 2.53% while the 10-yr note yield, which is more sensitive to inflation, slipped one basis point to 2.83%.

Within the stock market, every sector was a winner.

Gains ranged from 0.3% (consumer staples) to 1.4% (health care).  The latter was helped by a huge gain in Biogen (BIIB), which surged after announcing encouraging, and surprising, Phase II trial results for its Alzheimer’s drug.

A 1.2% increase in the information technology sector, which flowed from the outperformance of Apple (AAPL), Facebook (FB), Alphabet (GOOG), and Microsoft (MSFT), solidified the upside bias and drove the outperformance of the Nasdaq Composite (+1.3%).

Trade matters were talked about widely.  The U.S. and China both pressed ahead with tariffs on $34 billion worth of imported goods from each country, which was not a surprise, and President Trump suggested it’s possible tariffs on more than $500 billion of Chinese goods could be levied over time if necessary.

The latter was a surprise, but judging by the stock market’s performance, it was not unnerved by the remark.

Taking a closer look at today’s economic data:

Market Internals – Friday 06 June

Dollar: Pullback Extended

The U.S. Dollar Index closed down 0.46% at 93.96 on Friday, completing its fifth decline out of the past six sessions. The greenback retreated in overnight action, dropping to a fresh session low after the release of a June Employment Situation report, which exceeded headline expectations (213K; consensus 195K), but once again showed sluggish average hourly earnings growth (+0.2%; consensus 0.3%). The Dollar Index hit its low in Friday’s mid-morning trade, pausing just above its 50-day moving average (93.86). With Friday’s decline, the Dollar Index is down 0.6% for the week.

Bonds: Holiday Week Ends with Gains

U.S. Treasuries ended the abbreviated week on a broadly higher note, though intraday action saw a pullback from morning highs. The Treasury market began the day with modest gains, rallying to session highs after the release of an Employment Situation report for June, which stayed true to trend. The report showed a healthy increase in payrolls, but average hourly earnings growth remained subdued. On the whole, the report is unlikely to alter the policy course at the Federal Reserve, which is why the long bond hit its best level in five weeks in morning trade. The 30-yr bond retreated from its high in midday action, but that pullback could not prevent the 30-yr yield from ending the day at its lowest level since the end of January. The slope of the yield curve steepened today, but flattened over the course of the week. The 2s10s spread expanded by two basis points to 30 bps, but tightened by two basis points for the week. For its part, the 2s30s spread widened by two basis points to 41 bps, but tightened by four basis points for the week.

The yield curve tightened for yet another week as longer maturities’ yields fell more than the shorter maturities. The spread between the 5s10s tightened to 11bps from 12bps the previous week while the 10s30s tightened to 11bps from 13bps the previous week. This is the flattest curve since December 2006/January 2007 with the spread between the 2yr and the 30yr at only 41bps.

 Commodities 

The Bloomberg Commodity Index settled at 86.21, lower than 87.41 the previous week as energy and metals weaken.

WTI oil closes below $74/barrel. The spread between WTI and Brent narrowed for the seventh straight week to a more reasonable $3.31 from $5.29 the previous week (from $6.25 the week before).

EIA petroleum data for the week ended June 29

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 1.2 mln barrels from the previous week. At 417.9 mln barrels, U.S. crude oil inventories are about 2% below the five year average for this time of year. Total motor gasoline inventories decreased by 1.5 mln barrels last week and are about 6% above the five year range. Finished gasoline and blending components inventories both decreased last week. Distillate fuel inventories increased by 0.1 mln barrels last week and are about 13% below the five year average for this time of year. Propane/propylene inventories increased by 2.9 mln barrels last week and are about 10% below the five year average for this time of year. Total commercial petroleum inventories increased by 3.3 mln barrels last week.

Natural gas inventory Natural gas inventory showed a build of 78 bcf vs a build of 66 bcf in the prior week. Working gas in storage was 2,152 Bcf as of Friday, June 29, 2018, according to EIA estimates. This represents a net increase of 78 Bcf from the previous week. Stocks were 717 Bcf less than last year at this time and 493 Bcf below the five-year average of 2,645 Bcf. At 2,152 Bcf, total working gas is within the five-year historical range.

Baker Hughes total U.S. rig count increased by 5 to 1052 following last week’s decrease of 5.

Metals: Gold stops falling, Silver and Copper continue to weaken

Agriculture: Corn stalls, Wheat resumes its weakness, Soy bounces

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THE WEEK AHEAD

Week 28 (July 09 to 13) tends to be bullish across our 5, 10 and 15 year seasonal models.

Benchmarks (21 year average) for wk28:

Key Economic Dates

Week 28

This coming week, the US will publish inflation rate, the preliminary estimate of Michigan consumer sentiment, producer and foreign trade prices. Other key economic data include: UK first publication of monthly GDP; China inflation, producer prices and foreign trade; Japan machinery orders; and Australia business and consumer morale.

Mon 09 July

Tue 10 July

Wed 11 July

Thu 12 July

Fri 13 July

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OBSERVATION

The DOW Industrials and Transports broke and closed above its 200DSMA after languishing for eight sessions below that critical indicator. However, leadership in the last few sessions have come from the defensive sectors like healthcare, utilities and telecom amidst businesses that were “scaling back, or postponing, capital spending plans as a result of the uncertainty over trade policy“. The last two weeks’ action has also been against lower average volumes and rather divergent market internals.

One would be forgiven for thinking that this is usually the case leading up to the start of Q3’s earnings season. Earnings season for Q2 results begin in the coming week. JPM, WFC and C kicks starts what is usually the year’s most volatile earnings season on Friday 13 July – an ominous sign?

So while on the surface, things look to be back to normal and hunky dory, the undercurrents are starting to look threatening and worrisome again.

SUMMARY

Last week, I wrote; “Keep watching the yield curve – I am guessing that’s where the bulls have been running to.

With the yield curve spreads narrowing to yet another multi-year low, the volatile months (of August and September) ahead may just force this flattening into an inversion. According to historical tradition, this will give the market another six months (to a year) before we see any serious weakness in the economy. Thus, with the Fed’s language still bullish on rates, this market may still have legs to stay up till the end of the year unless August and September bring a difference perspective.

Till then, I remain cautiously bullish

Happy Hunting!

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