Weekly Market Analysis – 12 November 2018 BMO

WEEK IN REVIEW – 05 to 09 NOVEMBER 2018 :
Fed Policy Statement Not Enough to Derail U.S. Midterm Gains

The S&P 500 rose 2.1% this week, but had to weather a late week sell-off after the latest policy statement from the Federal Reserve humbled an upbeat reaction to the midterm elections. Neither outcome was a surprise, but they were representative of recent market volatility. The Dow Jones Industrial Average and the Nasdaq Composite also finished the week higher, adding 2.8% and 0.7%, respectively. The Russell 2000 added 0.1%.

The midterm elections produced a split Congress with the Democrats taking control of the House and the Republicans retaining control of the Senate. The prevailing assumption in the market was that a newly divided Congress would preserve market-friendly policies, namely the tax cut and deregulation efforts. In addition, investors took delight in the fact that the stock market has historically done well in years with a Republican president and split Congress.

The Fed released its policy statement on Thursday, in which it decided to leave the fed funds rate unchanged as expected. The central bank noted that it expects further rate hikes that are consistent with sustained economic growth, strong labor market conditions, and inflation near its symmetric 2% target over the medium term, but omitted October’s sell-off and U.S.-China trade developments from its policy statement. Those omissions were a clear, between-the-lines message that the FOMC remains poised to raise rates for a fourth time this year in December.

In the stock market, the health care (+4.0%), real estate (+3.6%), and utility (+3.1%) groups led the way. Of note, health care has surpassed the information technology (+1.4%) and consumer discretionary (+2.0%) sectors for the top spot in the yearly sector standings with a 2018 gain of 12.4%. For comparison, tech is up 10.7%, and consumer discretionary is up 10.9%.

Conversely, the communication services sector was the only group to finish in negative territory with a weekly loss of 0.2%.

In earnings, some notable companies that had upbeat reports included Berkshire Hathaway (BRK.B), CVS (CVS), Eli Lilly (LLY), Humana (HUM), and Walt Disney (DIS). On the other hand, Skyworks Solution (SWKS) led chip stocks lower on Friday after it issued below-consensus Q1 earnings and revenue guidance. Skyworks, which is an Apple (AAPL) supplier, warned of slowing chip demand, continuing a disappointing trend out of the semiconductor industry.

On a related note, Japan’s Nikkei Asian Review reported that Apple decided to cancel a production increase in its newest low-end iPhone XR. However, the Nikkei also said that demand for the older generation iPhone 8 and iPhone 8 Plus has been higher than expected. Nevertheless, the report corroborated fears over the company reaching peak iPhone sales.

In politics, Attorney General Jeff Sessions resigned his post effective immediately per President Trump’s request. Pot stocks initially surged in response to his resignation, as his adamant anti-marijuana stance has been seen as a roadblock to advancing the national discussion for legalization. However, pot stocks pulled back as replacement names currently being floated are against marijuana legalization; acting Attorney General Matthew Whitaker has a mixed record on the issue.

Looking at other markets, U.S. Treasuries had a volatile week, and closed near last week’s levels. This week, the 2-yr yield decreased two basis points to 2.91%, and the 10-yr yield added two basis points to 3.21%.

Also of note, WTI crude lost 4.8% this week, entering bear market territory and extending its decline from last month’s four-year high. U.S. President Donald Trump granted temporary wavers on Monday to eight countries who import oil from Iran after the U.S.’s energy sanctions on the OPEC member were officially reimposed.

(Economic Excerpts from Briefing.com)

U.S. ECONOMIC UPDATE

Monday 05 November:

ISM Non-Manufacturing Index Sees Some Natural Slowing in October

The ISM Non-Manufacturing Index for October checked in at 60.3% (consensus 58.8%).  That was down slightly from 61.6% in September, which was the highest reading for the composite index since its inception in 2008.

The key takeaway from the report is that business activity in the non-manufacturing sector is still strong, as the October deceleration can be interpreted at this juncture as a natural slowing following some solid acceleration since July when the index registered 55.7%.

Wednesday 07 November:

Consumer Credit Expansion Softens in September 

Total outstanding consumer credit increased by $11.0 billion in September after increasing an upwardly revised $22.8 billion (from $20.1 billion) in August.

The key takeaway from the report is that it reflects a deceleration in credit expansion that could contribute to concerns about the U.S. economy hitting/nearing peak growth.

Thursday 08 November:

Initial and Continuing Claims Continue to Garner Fed’s Close Attention

Initial claims for the week ending November 3 decreased by 1,000 to 214,000 (consensus 213,000) while continuing claims for the week ending October 27 decreased by 8,000 to 1.623 million.

The key takeaway from the report is that it is supportive of the Federal Reserve’s rate-hike bias.

Friday 09 November:

October PPI Generates Some Inflation Surprise

The Producer Price Index for final demand jumped 0.6% in October (consensus +0.2%) while the index for final demand, less food and energy, rose 0.5% (consensus +0.2%).

Those increases left the index for final demand up 2.9% year-over-year, versus 2.6% in September, and the index for final demand, less food and energy, up 2.6% year-over-year, versus 2.5% in September.

The key takeaway from the report is that it will stoke concerns about pass-through inflation to the consumer, which have already been stoked by numerous companies during the third quarter earnings-reporting period talking about higher input costs and increasing prices.

Consumer Sentiment Holds at High Level in November

The preliminary University of Michigan Index of Consumer Sentiment for November held quite steady, edging down to 98.3 (consensus 98.0) from the final reading of 98.6 for October.

The key takeaway from the report is that stock market sell-off in October had no real impact on consumer sentiment, which was rooted more in favorable views about income expectations and job growth that are key drivers of consumer spending.

Wholesale Inventories Increase in September 

Wholesale inventories increased 0.4% in September (consensus 0.3%) on top of a downwardly revised 0.9% increase (from 1.0%) in August. Wholesale sales were up 0.2% following a 0.7% increase in August.

The key takeaway from the report is that sales are increasing year-over-year at a faster rate than inventories, which can be a precursor to improved pricing power for wholesalers.

Other International Events of Interest

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FOMC Monetary Policy Statement
Thursday 08 November
Fed leaves rates unchanged at 2.00-2.25%
Economic activity has been rising at strong rate

Fed Talk: A Policy Directive with a Hitch

The November Federal Open Market Committee (FOMC) meeting went off without a hitch. There was unanimity in the decision to leave the target range for the fed funds rate unchanged at 2.00% to 2.25%.  In turn, there were a lot of similarities in the wording of the November directive with the one issued in September.

The one hitch, if it can be called that, is that the FOMC statement acknowledged business fixed investment has moderated. Even so, the FOMC still expects “further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”

There was no mention of concerns related to the stock market sell-off in October or the increase in protectionist trade measures. Those omissions were a clear, between-the-lines message that the FOMC remains poised to raise the target range for the fed funds rate again in December.

This directive shouldn’t elicit much of a trading response since it was very much in-line with prevailing expectations ahead of its release. Nevertheless, it serves as a timely reminder that monetary policy is less of a friend to the stock market than it was in the past.

The Federal Reserve says the risks to the economic outlook appear roughly balanced, yet that isn’t the case with monetary policy itself.  The risk with the fed funds rate is tilted to the upside since labor market conditions remain strong and inflation trends are firm.

The latest FOMC meeting may have been conducted without a hitch, yet that doesn’t mean there isn’t a hitch for the stock and bond markets.

The specter of rising rates is plain to see, yet there is ongoing uncertainty over how much further the target range for the fed funds rate will increase. That will be an ongoing source of volatility for both markets.

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Friday 09 November
S&P500 Pulls Back from Midterm Election Spike

The S&P 500 lost 0.9% on Friday, with the pullback suggesting a natural consequence of an overreaction to this week’s election spike. The Dow Jones Industrial Average lost 0.8%, the Nasdaq Composite lost 1.7%, and the Russell 2000 lost 1.8%. For the week, the S&P 500 advanced 2.1%.

Outperforming the broader market on Friday were the defensive-oriented consumer staples (+0.5%), real estate (+0.1%), and utilities (+0.1%) sectors. Conversely, FANG stocks within the lagging communication services (-1.5%), consumer discretionary (-1.5%), and information technology (-1.7%) sectors underperformed. Netflix led the FANG group lower with a loss of 4.6%. Apple (AAPL), Amazon (AMZN), Alphabet (GOOG), and Facebook (FB) bared losses between 1.5% and 2.4%.

Chip stocks dragged on the lagging tech sector, as key Apple supplier Skyworks Solutions (SWKS) fell 8.1% after it issued below-consensus top and bottom line guidance for its fiscal first quarter. Its guidance has extended a trend within the semiconductor industry that has warned of slowing chip demand. The Philadelphia Semiconductor Index lost 1.9%.

In other corporate news, Walt Disney (DIS) rose after an upbeat earnings report, while General Electric (GE) took a hit after JPMorgan cut its price target on the stock to $6 from $10. In response, the former Dow component responded that it is a “fundamentally strong company with a sound liquidity position,” according to a CNBC report.

Demand for Treasuries increased amid the equity setback, pushing yields lower across the curve. The 2-yr yield lost four basis points to 2.93%, and the 10-yr yield lost five basis points to 3.19%. For the week, the 2-yr yield added two basis points, while the 10-yr yield shed two basis points.

Separately, WTI crude, which is the U.S. benchmark for oil, fell 0.9% to settle at $60.16/bbl. Friday’s loss has extended its decline to 21.8% from its Oct 3 four-year high. On a related note, the oil-sensitive energy sector lost 0.4% on Friday.

In trade news, White House National Trade Council Director Peter Navarro made some combative comments against CEOs for pushing President Trump to make a trade deal with China and stated a trade deal will be on the president’s terms. Separately, President Trump has reportedly been telling associates that he wants to replace Commerce Secretary Wilbur Ross by the end of the year.

Overseas, China reported just a 0.2% rise in its Consumer Price Index on Friday, which was in-line with estimates but significantly below last month’s increase of 0.7%. Its softening inflation has continued to fuel concerns over a slowing Chinese economy.

Market Internals – Friday 09 November 2018

Dollar: October High in Sight

The U.S. Dollar Index closed up 0.2% at 96.90, in its second consecutive advance. The Dollar Index built on Thursday’s rally, but Friday’s uptick was more modest. The dollar saw some pressure in morning trade, but pullbacks have been met with rebounds to fresh highs, putting the Index just below its high from October (97.20). The Dollar Index gained 0.4% for the week after being down 0.9% on Wednesday morning.

Bonds: Belly of the Curve Leads Treasuries Higher

U.S. Treasuries ended the week on a flatter note across the curve. Treasuries started the Friday session on a higher note after Treasury futures rallied during a weak overnight showing from Asian and European equity markets. Treasuries backed down from their opening levels after the release of a hotter than expected PPI report for October (actual 0.6%; consensus 0.2%), but it wasn’t long before the complex reversed again, rising to fresh highs. Treasuries continued advancing into the early afternoon against the backdrop of falling equities and continued weakness in crude oil. Crude oil futures saw their tenth consecutive decline, which pressured price to levels from early March. The nine-day slide makes for a continuation of selling pressure that appeared in October. Crude oil is now down nearly 22.0% from its early-October high, fueling concerns that the recent weakness is a statement about fading global growth. The Treasury yield curve faced notable flattening pressure this week, as the 2s10s spread tightened by four basis points to 26 bps while the 2s30s spread narrowed by eight basis points to 46 bps.

The yield curve flattened across the board. The spread between the 5s10s narrowed to 15bps from 17bps the previous week while the 10s30s narrowed to 20bps from 24bps the previous week. The 2-30 spread has narrowed to 46bps from 54bps a week ago.

Commodities 

The Bloomberg Commodity Index settled at 82.89, lower than 83.88 the previous week as energy and metals took a lot of pressure.

WTI oil fell, settling the week at $60.19. The spread between WTI and Brent widened to $9.99 from $9.69 the previous week as Brent settled at $70.18 p/b.

EIA petroleum data for the week ended November 02

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 5.8 mln barrels from the previous week. At 431.8 mln barrels, U.S. crude oil inventories are about 3% above the five year average for this time of year. Total motor gasoline inventories increased by 1.9 mln barrels last week and are about 8% above the five year average for this time of year. Finished gasoline inventories decreased while blending components inventories increased last week. Distillate fuel inventories decreased by 3.5 mln barrels last week and are about 6% below the five year average for this time of year. Propane/propylene inventories increased by 1.5 mln barrels last week and are at the five year average for this time of year. Total commercial petroleum inventories increased last week by 4.8 mln barrels last week. 

Natural gas inventory showed a build of 65 bcf vs a build of 8 bcf in the prior week. Working gas in storage was 3,208 Bcf as of Friday, November 2, 2018, according to EIA estimates. This represents a net increase of 65 Bcf from the previous week. Stocks were 580 Bcf less than last year at this time and 621 Bcf below the five-year average of 3,829 Bcf. At 3,208 Bcf, total working gas is below the five-year historical range.

Baker Hughes total U.S. rig count increased by +14 to 1081 following last week’s decrease of -1.

Metals: Precious Corrrects Further

Agriculture: Grains Falter

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THE WEEK AHEAD
Week 46 (November 12 to 16)

According to our 5, 10 and 15 year seasonal models;

Benchmarks Indices (21 year average) for wk46:

Week 46 Key Economic Dates

In the coming week the most important releases include US inflation, retail sales and industrial production; UK inflation and employment; Germany and Japan Q3 GDP growth; China industrial output, retail sales and fixed asset investment; India inflation; and Australia employment.

Mon 12 November

Tue 13 November

Wed 14 November

Thu 15 November

Fri 16 November

Earnings 

Third quarter earnings season is wrapping up with 90% of the S&P 500 having reported quarterly results. Third quarter EPS are now expected to grow just over 25% in aggregate with sales up 9.3%. Expectations were for 19% EPS growth with sales up 7% heading into the reporting season. Just over 77% of the S&P 500 beat earnings estimates while 62% beat revenue estimates; 52% traded higher in response.

Fourth quarter EPS are expected to grow 14.3% with sales up 6.7%. Expectations were for 17% EPS growth with revenue up 6.5% one month ago. Estimates for the following quarter normally get pared down a bit based on conservative guidance but higher input costs (raw materials, transportation, wages, etc.) have consistently been cited as a headwind this earnings season.

For 2018 as a whole, S&P 500 EPS are expected to grow 20.6% with sales up 9%, marginally higher than one month ago. In 2019, EPS are expected to grow 9% with sales up 5.5%. But third quarter earnings season isn’t over just yet. Retail earnings season starts kicks off next week and ends Earnings Season on Thursday with WMT’s results.

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COMMENTARY

“I might start lightening my hedges and prepare for the annual year-end bull run if this market doesn’t fall apart after the FOMC Policy Meeting.”

It’s the last week of earnings season and its back to normal trading without the excessive volatility. I am expecting to see some semblance of normalcy returning to the market. If it does this week, I am back to the usual seasonal trades starting with the retail sector as earnings season winds down.

Happy Hunting!

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