Market Update: Tuesday, July 11, 2017

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Yesterday’s Market Activity

  • S&P 500 (0.1%) up for second day on light trading. Technology rebounded (0.8%) from last week’s selloff.
  • Dow near flat, Russell 2000 -0.50%.
  • Bonds recovered from last week’s drop, U.S. dollar strengthened.
  • Industrial metals advance continued relative to precious metals, typically a good harbinger for growth.
  • As global stocks rally, with many markets near all-time highs, investors shrugging off political uncertainty, placing emphasis on return to corporate profit growth, which is not isolated to U.S.

Overnight & This Morning

  • Asian stocks rose again, led by technology. MSCI Emerging Markets, Asia Pacific Indexes, each +0.7%, Shanghai Composite -0.3%.
  • Yen weakness ($114 USD) powered Japanese exporters, Nikkei +0.6%; strong demand in 5-year Japanese government bond auction.
  • European stocks slipped, defensive sectors including food, real estate lead declines; Euro Stoxx 600 -0.2%.
  • Sovereign bonds weakened, yet bund held around 0.56%.
  • Euro held steady around $1.13/USD.
  • Commodities – WTI crude oil ($44.30/bbl.), COMEX gold ($1210/oz.) both slid ~0.25%.
  • Most industrial metals up, copper +0.5%.
  • Treasury yields, dollar up ahead of tomorrow’s testimony by Fed Chair Janet Yellen; 2-year Treasury 1.39%, 10-year 2.39%.
  • Broad U.S. stock indexes little changed in early trading; bank stocks higher following nomination of Randal Quarles as Fed’s top banking regulator.
  • Dodd-Frank may be difficult to overhaul, but reduced regulatory pressure from Fed (stress tests, capital requirements, etc.) could free up excess capital for lending, increasing velocity of money.

 

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Key Insights

  • Magnificent Seven. Provided by Strategas Research Partners, the following seven reasons for the potential continuation of the bull market were given by Steve Einhorn and Lee Cooperman of Omega Advisors:
    1. A potentially low risk of recession and a strong chance of a long-lasting recovery
    2. A sweet spot for gross domestic product (GDP) of 2%-3%, enough to underpin moderate earnings per share (EPS) growth
    3. A sweet spot for inflation of 2%-2.5%, enough to aid S&P 500 Index revenue and corporate earnings, but not enough to scare the Federal Reserve (Fed) and the bond market
    4. A friendly Fed and slow rate normalization; and this, with tame inflation, should keep any lift in bond yields modest, manageable, and of little threat to the equity market
    5. No Fed hostility toward risk markets until wage inflation exceeds 3.25%, which is potentially a long way off
    6. Cautious investor sentiment/positioning
    7. U.S. equity valuations are not currently excessive or speculative (especially when considered relative to inflation and interest rates)
  • “Bearish Flatteners” can be a positive for equities. In bond parlance, a “Bear Flattener” is when short-term interest rates are rising at a faster rate than long-term rates, similar to the environment we are experiencing now. Year to date, the yield on the 2-year Treasury has climbed approximately 20 basis points (0.20%), compared to a decrease of ~7 basis points (0.07%) for the benchmark 10-year Treasury yield. The last two bear flatteners occurred in mid-2003 and late-2013, periods which saw the S&P 500 climb for at least four years thereafter. Bank stocks, asset managers, and insurers are also acting well in this environment, pointing toward future growth in the economy and profits.

Fixed Income Notes

  • Treasury prices fell last week as the market continued to adjust to hawkish commentary both in the U.S. and internationally. Selling pressure early in the week led to higher yields across the curve, with the 2-year Treasury yield hitting year-to-date highs, finishing higher by 0.02% at 1.40%; 5-year Treasury yield finishing up 0.06% at 1.95%, and the 10-year Treasury yield finishing higher by 0.08% to 2.39%. The long end of the curve, represented by the U.S. 30-year Treasury, was higher on the week by 0.09% at 2.93%.
  • International bond prices followed U.S. Treasuries lower. Since June 26th, Italian yields were 0.40% higher, moving from 1.87% to 2.27% on Friday. Hawkish commentary also led the Canadian 10-year yield higher by 0.41% to 1.86%. Higher quality bonds in Germany fared better, but 10-year yields still moved 0.31% higher to 0.54%. This puts the U.S. 10-year advantage to the German 10-year at 1.84%. Note that the German 2-year yield is currently -.605% which puts the U.S. 2-year advantage at 2.00%.
  • The Treasury yield curve was steeper on the week. The 2-year Treasury moved higher in yield but less than the 10-year, leading to a steeper yield curve. Generally, when the Fed hikes rates, the 2-year cheapens in price (moves higher in yield) more than the longer bonds. This occurred earlier in June, but with hawkish commentary late in the month, 10-year prices weakened more dramatically. This brings the 2’s to 10’s slope, a measure of the steepness of the yield curve to 99 basis points (0.99%), steeper by 6 basis points (0.06%).
  • Inflation expectations moved higher. The 10-year breakeven inflation rate finished the week slightly higher, moving from 1.73% to 1.76%. This is well below the Fed’s 2% inflation target but off the 1.66% low for the year reached on June 20. Declining commodity and oil prices have inflation in check at this time.
  • U.S. Treasury long positions declined slightly. The latest Commitments of Traders report, released by the CFTC (data through June 30, 2017) shows that net-long bets in 10-year Treasury notes declined somewhat as traders became more bearish last week. The net-longs are still elevated however.
  • High-yield corporate spreads widen slightly. The option adjusted spread (OAS), which measures the yield differential between high-yield corporates and U.S. Treasuries, widened from  3.77% to 3.83% on the week. Recent oil weakness is reflected in this move. Note that high yield has outperformed the U.S. Aggregate Bond Index by 2.78% year to date (4.68% vs. 1.90%). For the trailing 3 month period, investment-grade corporates, with less oil exposure and longer duration, outperformed high yield by 0.17% (1.76% vs. 1.59%).

 

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Click Here for our detailed Weekly Economic Calendar

Tuesday

  • NFIB Small Business Optimism (Jun)
  • Wholesale Sales & Inventories (May)
  • Italy: Industrial Production
  • Bank of England: Inflation Report Hearings
  • Japan: Machine Tool Orders (Jun)
  • Japan: PPI (Jun)
  • China: Trade Balance (Jun)
  • China: Imports & Exports (Jun)

Wednesday

Thursday

  • PPI (Jun)
  • Monthly Budget Statement (Jun)
  • Germany: CPI (Jun)
  • France: CPI (Jun)

Friday

  • CPI (Jun)
  • Retail Sales (Jun)
  • Industrial Production & Capactiy Utilization (Jun)
  • Italy: CPI (Jun)
  • Japan: Industrial Production & Capacity Utilization (May)

 

Past performance is no guarantee of future results.

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

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