Weekly Market Analysis – 08 October 2018 BMO

WEEK IN REVIEW – 01 to 05 OCTOBER 2018 :
Stocks Fall As Yields Surge

The S&P 500 fell 1.0% this week, weighed down by a surge in bond yields, which rose to multi-year highs in front of Friday’s release of the Employment Situation report for September. The tech-heavy Nasdaq and the small-cap Russell 2000 underperformed, losing 3.2% and 3.7%, respectively, but the blue-chip Dow finished flat.

Stocks began the week on a positive note, boosted by Canada joining Mexico and the United States in a trade agreement. On Sunday night, Canada agreed to allow greater dairy market access to the U.S., while also capping its automobile exports to the States. The deal, also known as the United States-Mexico-Canada Agreement (USMCA) replaces the 24-year-old NAFTA deal between the countries. However, Congress still has to approve the deal, which likely won’t be easy.

Investors awoke to continued Italian drama on Tuesday, when Italy’s anti-establishment government defended its plan to increase the country’s budget-deficit target despite pushback from the EU. In addition, Claudio Borghi, who leads the economic policy of the ruling Lega party, claimed that most of Italy’s problems could be solved if the country had its own currency – although that idea was dismissed by Italy Deputy Prime Minister Di Maio.

However, on Wednesday, Italy’s government decided to cede to some of the EU’s budget demands. Italy’s budget-deficit target will be reduced from 2.4% of GDP in 2019 to 2.2% in 2020 and then to 2.0% in 2021.

That news helped push bond yields higher overnight. Yields then extended those gains significantly after the September ADP Employment Change report – a prelude to Friday’s nonfarm payrolls reading – showed an estimated 230K positions were added to private sector payrolls – well above the Briefing.com consensus estimate of 184K. The ISM Services Index for September also came in better-than-expected on Wednesday, hitting a record high of 61.6% (consensus 58.2%), clearly indicating that business activity in the service-providing sector of the economy is strong.

Yields continued to advance on Thursday and then again on Friday following the release of the Employment Situation report for September. The report showed a smaller-than-expected increase in nonfarm payrolls (134K actual vs 184K consensus), but the August increase underwent a notable upward revision (to 270K from 201K). As for the rest of the report, average hourly earnings increased 0.3% (consensus +0.3%), the average workweek was reported at 34.5 (consensus 34.5), and the unemployment rate dropped to 3.7% from 3.9%.

The key takeaway from the September jobs report is that the labor market is solid and still simmering with the prospect of pent-up wage pressures being unleashed at any point as employers encounter difficulty in finding qualified workers.

Looking at this week’s S&P sector standings, most groups finished in negative territory. The consumer discretionary sector led the retreat with a loss of 4.2%, and information technology (-2.0%) and communication services (-2.0%) also showed relative weakness. On a positive note, the influential financial sector advanced 1.7%, benefiting from rising yields and, more specifically, a steepening of the yield curve. The benchmark 10-yr yield jumped 16 basis points in total, closing Friday at 3.23% – which marks its highest level since 2011 – while the 2-yr yield jumped five basis points to 2.88%.

In corporate news, General Electric (GE) replaced CEO John Flannery with former Danaher CEO Larry Culp; Tesla’s (TSLA) CEO, Elon Musk, agreed to settle charges with the SEC, in which Mr. Musk and Tesla are to pay $20 million each, and Mr. Musk is to step down as chairman for three years; Amazon (AMZN) announced that it will be raising its minimum wage to $15 an hour for all U.S. employees, pressuring other retailers to do the same; and General Motors (GM) announced that it will be partnering with Honda Motor (HMC) to build autonomous vehicles.

(Economic Excerpts from Briefing.com)

Monday 01 October

ISM Manufacturing Index Pulls Back in September

The ISM Manufacturing Index for September declined to 59.8% (consensus 60.4%) from 61.3% in August. The dividing line between expansion and contraction is 50.0; and September marked the 24th consecutive month of expansion.

The key takeaway from the report is that even with the September pullback, the Index remains near multi-year highs with continued growth in most sub-indices.

Construction Spending Growth Shy of August Estimates 

Total construction spending increased 0.2% in August (consensus 0.4%) following a downwardly revised 0.2% increase (from 0.1%) in July.

The key takeaway from the report is that public construction spending has continued driving the overall growth rate while private construction spending growth has moderated.

Wednesday 03 October

September ADP Employment Change 230K vs 184K consensus; August revised to 168K from 163K :

ISM Non-Manufacturing Index Hits Record High in September

The ISM Non-Manufacturing Index checked in at 61.6% for September (consensus 58.2%), up from 58.5% in August.  According to the Institute for Supply Management, that is the highest reading for the Non-Manufacturing Index since the inception of the composite index in 2008. The dividing line between expansion and contraction is 50.0%.

The key takeaway from the report is that it clearly indicates business activity is strong for the service-providing sector of the economy, which accounts for a much larger slice of economic activity than the manufacturing sector does.

Thursday 04 October

Initial Claims Dip amid Tight Labor Market Conditions

Initial claims for the week ending September 29 decreased by 7,000 from the prior week to 207,000 (consensus 210,000) while continuing claims for the week ending September 22 decreased by 13,000 to 1.650 million.

The key takeaway from the report is that it shows the labor market remains tight and conducive to an increase in wage growth.

Friday 05 October

September Jobs Report Mixed, but Message Still the Same, Unemployment drops to lowest level since 1969

September nonfarm and private sector payrolls were much weaker than expected. That will be attributed by some sources to the effects of Hurricane Florence, but the overriding point is that upward revisions to August nonfarm and private sector payrolls more than compensated for the headline misses for September.

The key takeaway from the report is that the labor market is solid and still simmering with the prospect of pent-up wage pressures being unleashed at any point as employers encounter difficulty in finding qualified workers.

Trade Deficit Widens in August

The Trade Balance Report for August showed a widening in the trade deficit to $53.2 billion from an upwardly revised $50.0 billion (from -$50.1 billion) in July.

The key takeaway from the report is that it has yet to confirm the tariff actions are succeeding in cutting the trade deficit in a big way; moreover, with the third quarter real average trade deficit 8.9% higher than the second quarter average, trade will be accounted for as a negative input in Q3 GDP forecasts.

Consumer Credit Expands in August

Total outstanding consumer credit increased by $20.1 billion in August after increasing an unrevised $16.6 billion in July.

The key takeaway from the report is that it reflects a pickup in credit demand that should be construed as an offshoot of a strengthening economy led by a solid labor market.

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Friday 05 October
Rising Rates Drive Falling Stock Prices

The stock market fell on Friday as bond yields continued to climb following the release of the Employment Situation report for September. The S&P 500 and the Dow lost 0.6% and 0.7%, respectively. The tech-heavy Nasdaq dropped 1.1%.

At its session low, the S&P 500 was down 1.1%, falling below its 50-day moving average for the first time since July. The market eventually gathered its footing though, closing near the middle of the day’s trading range.

The Employment Situation report for September was mixed from a headline standpoint, as nonfarm payrolls showed a below-consensus increase of 134,000 (consensus 184K), but the August increase was revised upward to 270,000 (from 201K). Average hourly earnings rose 0.3%, as expected, and the unemployment rate fell to from 3.9% to 3.7%, marking its lowest level since 1969.

U.S. Treasuries extended their weekly losses following the release of the jobs report, pushing yields higher across the curve. The 2-yr yield advanced one basis point to 2.88%, and the benchmark 10-yr yield jumped three basis points to 3.23%, extending its weekly gain to 16 basis points and marking its highest close since 2011.

In corporate news, Costco (COST) lost 5.6% despite reporting above-consensus earnings, and Tesla (TSLA) dropped 7.1% after CEO Elon Musk seemingly mocked the SEC in a late Thursday tweet, just days after agreeing to a settlement with the agency over securities fraud allegations stemming from his failed bid to take the company private.

Market Internals – Friday 05 October 2018

Dollar: Gains for the week

The U.S. Dollar Index closed higher for the week +0.5% but down on Friday -0.1% at 95.60, tracking its first decline since last Tuesday. The Dollar Index spent the Thursday overnight session near its flat line and rallied briefly in immediate response to the Employment Situation report for September, which missed headline expectations, but contained an upward revision to the August reading. The post-data rally did not last, as the Index slipped to a session low in mid-morning trade, but recovered a portion of its loss before the afternoon. The Dollar Index remains on course for its second consecutive weekly advance, having climbed 0.5% since last Friday.

Bonds: 10yr Yield breaks to its highest since 2011

U.S. Treasuries ended a down week on a lower note. Treasury futures saw limited movement in overnight trade, putting the cash market on track for a flat start. The flat open preceded the release of the Employment Situation report for September, which was a mixed bag. Granted, the headline reading missed expectations (actual 134K; consensus 184K), but the August reading was revised up by 69,000 while the Unemployment Rate (3.7%) fell to its lowest level since 1969. Treasuries saw some impulse buying immediately after the report crossed the wires, but the gains were erased in short order, opening the door to another slow, but steady retreat that continued into the afternoon. Atlanta Fed President Raphael Bostic, who is a voter on this year’s FOMC, made some hawkish comments during a midday speech. Mr. Bostic said he materially underestimated the underlying momentum in the economy, which means that a higher rate path may be required. The slope of the Treasury yield curve saw some steepening this week, as the 2s10s spread widened to 35 bps from last Friday’s 25 bps while the 2s30s spread ended the week 13 basis points wider at 52 bps. Keep in mind that the bond market will be closed for Columbus Day on Monday, but the equity market will be open.

The yield curve steepened as the longer maturities’ yields made double figure gains for the week while the 2yr yield only gained 7bps. The spread between the 5s10s widened to 16bps from 11bps the previous week while the 10s30s widened to 17bps from 14bps the previous week.

Commodities 

The Bloomberg Commodity Index settled at 86.90, (+1.70 +2.0%) higher than 85.20 the previous week as Energy, Agriculture and Gold all made handsome gains.

WTI oil broke above 76.00 on Wednesday and settled the week at $74.34. The spread between WTI and Brent widened to $9.82 from $9.47 the previous week.

EIA petroleum data for the week ended September 28

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 8.0 mln barrels from the previous week. At 404.0 mln barrels, U.S. crude oil inventories are at the five year average for this time of year. Total motor gasoline inventories decreased by 0.5 mln barrels last week and are about 7% above the five year average for this time of year. Finished gasoline inventories increased while blending components inventories decreased last week. Distillate fuel inventories decreased by 1.8 mln barrels last week and are about 3% below the five year average for this time of year. Propane/propylene inventories increased by 2.4 mln barrels last week and are about 8% below the five year average for this time of year. Total commercial petroleum inventories increased last week by 8.0 mln barrels last week.

Natural gas inventory showed a build of 98 bcf vs a build of 46 bcf in the prior week. Working gas in storage was 2,866 Bcf as of Friday, September 28, 2018, according to EIA estimates. This represents a net increase of 98 Bcf from the previous week. Stocks were 636 Bcf less than last year at this time and 607 Bcf below the five-year average of 3,473 Bcf. At 2,866 Bcf, total working gas is below the five-year historical range.

Baker Hughes total U.S. rig count decreased by -2 to 1052 following last week’s increase of 1.

Metals: 

Agriculture:

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THE WEEK AHEAD
Week 41 (October 8 to 12)

According to our 5, 10 and 15 year seasonal models, the DIA and SPY should be bullish all week especially towards the end of the week.

Benchmarks Indices (21 year average) for wk41:

Week 41 Key Economic Dates

For the week, important releases for the US include inflation rate, Michigan consumer sentiment and Federal monthly budget statement. Elsewhere: China trade, Caixin Services PMI and monetary indicators; UK monthly GDP figures and industrial production; and India inflation rate will also be in the spotlight.

Mon 08 October

Tue 09 October

Wed 10 October

Thu 11 October

Fri 12 October

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COMMENTARY

“With the rising CPI and higher inflation rate, there is little to hold the Fed back from yet another promised hike. The question is whether it will be  the October or December meeting that the hike happens.”

So we got another hike to 2.0% to 2.25%. And the week after, DOW and S&P break to new highs, further lending credence to my bullish opinion that when rates go higher, so does the market.

In the three years that the FFR rose from 0% in October 2015 to 2.25% in September 2018, the DOW rose by more than 60% while the S&P gained more than 50%. As long as the spread between the 10yr Yield and the FFR stay apart, I stay bullish.

If you want to read the full paper on the relation between the FFR, the 10yr and the benchmarks, check out this link: 
The Fed Fund Rate & The Market 2016

Another rate hike has been promised before the end of the year and it could either happen at the end of this month or in December. Ideally, I’d like to have a healthy correction before that otherwise, buying the high is not something I am comfortable doing in spite of the bullish promise of higher highs with higher rates.

The coming week will be the start of Earnings Season with C, WFC and JPM getting the party started on Friday. This is going to add yet another dimension to the volatility of the current market sentiment which always makes October’s Earnings Season an exciting roller coaster ride.

Happy Hunting!

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HAPPENING THIS WEDNESDAY!

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