Market Update: Tuesday, October 18, 2016

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  • Earnings spur stocks; domestic inflation in line. Equities are moving higher this morning as traders eye a flood of tier-one earnings reports, including Dow components Johnson & Johnson and IBM. This follows yesterday’s 0.3% decline in the S&P 500, Dow and Nasdaq as consumer discretionary (-0.8%) underperformed while the lesser-weighted utilities (+0.6%) and telecom (+0.2%) sectors advanced on a drop in Treasury yields. Across the pond, the U.K. reported higher-than-expected inflation for September, which is boosting commodity-related stocks and driving regional indexes higher by about 1.5% with Italy’s MIB (+1.8%) leading the pack. In Asia, the Shanghai Composite gained 1.4%, while the Nikkei added 0.4%. Meanwhile, WTI crude oil has moved back near $50/barrel, COMEX gold ($1260/oz.) continues to trade near its 200-day moving average and the yield on the 10-year Note is up 0.01% to 1.76%.

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  • 10-year Treasury heads higher. The 10-year Treasury yield continued its recent leg higher last week, ending the week at 1.8% before falling slightly on Monday. Though yields remain low relative to history, the 10-year Treasury yield is the highest of the G7 group of developed nations, a factor that has led to continued foreign demand for Treasuries. Last week saw 3-, 10-, and 30-year auctions, all of which saw a greater than average takedown from indirect bidders, a proxy for foreign demand.
  • Breakeven inflation also moving higher. Last week’s move in Treasury yields was at least partly driven by an increase in implied inflation. The recent recovery in the price of oil along with dovish comments on Friday from Fed Chair Janet Yellen helped drive breakeven inflation, as measured by the difference between the yield on the 10-year Treasury and 10-year TIPS, to end the week at 1.67%, its highest level since April. Though inflation expectations have been showing signs of life in recent weeks, they remain benign overall and still well below the Fed’s 2% target.
  • Emerging market debt weaker even as oil stabilizes. Emerging market debt (EMD) spreads have in general moved with the price of oil year to date, though the past week was one of the few exceptions, as EMD fell even though oil prices remained stable.  The few times that we have seen such a divergence in the past year have been driven by changing central bank expectations, and this time is no exception. The release of the Federal Reserve Bank’s (Fed) September meeting minutes showed that the decision to not raise rates was close, and this seemed to take a front seat for EMD investors. EMD remains one of the strongest fixed income performers of the year, with a total return of just over 14% (as measured by the JP Morgan EMBI Index).
  • High yield steams onward, arguing for caution. High yield’s impressive performance streak continued  last week, with the Barclays US High Yield Index outperforming the Barclays US Aggregate Index by 0.3% on the week. High-yield’s performance since the market’s recent low on February 11, 2016 has been historic, which has left the market on the expensive side of fair value. Some fundamentals are improving, prompting rating agencies to reduce their default forecasts for 2017. Much of that good news may already be priced into the market however, leaving high yield with little room for error and vulnerable to pullbacks in the price of oil or in equity markets. We take a deep dive into high yield in this week’s Bond Market Perspectives, due out later today.
  • Supply and Treasury performance hit municipal bonds. Municipal bonds lost 0.41% last week (as measured by the Barclays Municipal Bond Index). The asset class saw slight underperformance to Treasuries, with 10- and 30-year AAA municipal to Treasury ratios creeping higher to 96% and 101%, respectively. Municipals typically outperform Treasuries in rising rate environments, though supply, which continues to be elevated relative to history, was likely an additional headwind. Supply has been above average this year, mostly due to refunding activity, but some new supply has been issued.  We would expect supply to continue to be a headwind in the near future, as municipalities attempt to bring debt to the market ahead of the potentially market-moving events of the November elections and a possible December Fed rate hike.
  • CPI ran hot again in September, on path to hit Fed’s 2% target soon. Headline Consumer Price Index (CPI) rose 1.5% year over year in September, accelerating from the 1.1% year-over-year gain in August. It was the strongest reading since October 2015. Core CPI rose 2.2% year-over-year in September, a modest deceleration from the 2.3% increase in August. Beneath the surface, the CPI for services (two-thirds of CPI) posted a 3.0% gain over the past year–the strongest reading in almost eight years–while the CPI for goods (one-third of CPI and largely driven by food and gasoline prices) fell 1.5%, but is accelerating rapidly. As we approach the anniversary of the worst of the oil price declines in Q4 2015 and Q1 2016, the goods category should turn positive and drive headline inflation close to 2.0% by year-end 2016 and well above 2% in early 2017.
  • Positive data points for healthcare and financials. Results from broker Goldman Sachs continue the trend of better-than-expected results for capital markets and the financials sector overall. The upward pressure on interest rates, coupled with the generally solid results thus far, improves the near-term outlook for the sector. We view results from two big healthcare names this morning (Johnson & Johnson and United Health) as generally consistent with that sector’s favorable earnings growth prospects-consensus estimates for the S&P 500 Healthcare sector are calling for a 5% year-over-year earnings increase in Q3 and 8% in Q4 2016.
  • China between a rock and a hard place. China is expected to release its latest gross domestic product (GDP) data tonight, though it often moves data releases around by a day or two. Regardless of the official statistics (and the market is expecting a 6.7% increase) the underlying data suggest that China is struggling between expanding its already troubling level of debt and growing the economy. New loan data was released last night, with greater than expected increases in lending across the board, especially in consumer lending. The expectation is for the government to tighten monetary policy, and it has done so in some select areas, such as housing lending. But as of now, the credit taps are still wide open in China.
  • Bob’s Beige Book. In this week’s Weekly Economic Commentary, we examine the economic, political, and market landscape through the lyrics of Bob Dylan, who won the Nobel Prize for Literature last week. Don’t worry, we didn’t use the harmonica.
  • Is another ’87 style crash around the corner? With the 29th anniversary of the stock market crash of ’87 tomorrow, many charts are circling trading desks that show how this year looks a lot like ’87. If you overlay the S&P 500 action since the February lows this year with ’87, there is a striking resemblance between the two. So does that mean a one day drop of 22.6% is around the corner for the Dow? We don’t think so and today on the LPL Research blog we will show why this is unlikely.

MonitoringWeek_header 

Tuesday

Wednesday

  • Housing Starts and Building Permits (Sep)
  • Presidential Debate in Las Vegas
  • Beige Book
  • Dudley (Dove)
  • Brazil: Central Bank Meeting (Rate Cut Expected)

Thursday

  • Initial Claims (10/15)
  • Philadelphia Fed Mfg. Report (Oct)
  • Leading Indicators (Sep)
  • Eurozone: European Central Bank Meeting (No Change Expected)

Friday

Click Here for our detailed Weekly Economic Calendar

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Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

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