Market Update: Tuesday, July 25, 2017

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Yesterday’s Market Activity

  • U.S. stocks mixed, with the Dow -0.3%, S&P 500 -0.1%. Nasdaq +20 points to 6410, a new record level, powered by strength in biotech sector.
  • Investors have been focused this week on solid Q2 earnings along with anticipation of tomorrow’s Federal Open Market Committee policy statement. Fed not expected to increase rates, but more clarity on balance sheet reduction plans could be announced.
  • Consumer discretionary weighed on S&P 500; weakness in toymakers the biggest drag.
  • Bond proxies, such as utilities, also weak as bond prices fell.
  • 10-year Treasury yield rose 2 basis points (0.02%) to 2.25%.
  • U.S. dollar relatively steady after having been under pressure in recent weeks.

Overnight & This Morning

  • Asian stocks weak, dragged lower by industrial, technology shares. MSCI Asia-Pacific Index -0.2%, stocks in China’s Shanghai Composite fell by a similar magnitude. This despite rising forecasts for GDP in the world’s second largest economy.
  • Nikkei -0.1% as Shinzo Abe continued to lose ground in recent polling data. Minutes from June Bank of Japan meeting showed policymakers discussed “growing interest in the so-called exit” from its stimulus program.
  • European stocks rose after three days of declines, led by banks, which have been supported by stepper euro-area yield curves, according to Bloomberg. Indeed, European Central Bank President Mario Draghi’s comments last week about improving economic data have trumped any concerns about his hesitancy to remove stimulus.
  • Euro ($1.16) gains continue vs. U.S. dollar, approaching highest level in two years. The currency also helped by German business confidence hitting post-reunification high.
  • Commodities – Copper surged 2.0% and headed for its highest close in two years, precious metals were mostly lower, COMEX gold -0.3%.
  • WTI crude oil +1.0% amid potential supply disruptions from Venezuela. Further, two key energy companies, a production company and a servicing company, suggested upcoming slowdown in new drilling and exploration. This, combined with Saudi Arabia’s news yesterday promising to curtail oil production even further, are providing a lift.
  • U.S. stocks up slightly, yield on benchmark 10-year Treasury higher at 2.30%.
  • Dollar recovering modestly from recent weakness ahead of the of Fed meeting.
  • John McCain back in Washington, fueling reports of a Senate vote. Yet, it is still uncertain whether the vote is for repeal and replace, or simply repeal of the ACA. Speculation has also increased about employment prospects of HHS Secretary Tom Price and AG Jeff Sessions.

 

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Key Insights

  • U.S. dollar weakness can be a tailwind for corporate profits. The potential for a less aggressive Federal Reserve (Fed), weaker than expected gross domestic product (GDP) and inflation, and political uncertainty have combined to weaken the U.S. dollar by approximately 7.5% thus far in 2017. Foreign sales as a percentage of total S&P 500 Index revenues constitute more than 40% of the index’s total sales. As a result, a pickup in international economic activity and dollar pressure could well lead to positive earnings and currency translation effects. First Call estimates that the impact of this virtuous circle could lift S&P 500 earnings per share by an additional $2-$3 in the coming quarters, and this does not include potential adjustments for corporate tax cuts. Though stocks may not be considered cheap, the potential tailwinds from dollar weakness and fiscal reform are enough to keep us interested.

Fixed Income

  • Treasury prices were higher on the week. Treasury yields moved higher (prices lower) on the week. The yield on the U.S. 2-year Treasury finished higher by 1 basis point (0.01%) to 1.36%, while the 5-year Treasury ended the week lower by 6 basis points (0.06%) to 1.81%. The 10-year also moved lower in yield by 9 basis points (0.09%) to 2.24%. The long-end of the curve moved the most, lower in yield by 10 basis points (0.10%) to 2.81% on the 30-year bond.
  • The yield curve flattened on the week led by the long end. The Treasury yield curve flattened by 0.10% with the 2’s to 10’s slope, a measure of the steepness of the yield curve, ending the week at 88 basis points (0.88%). The 5’s to 30’s slope flattened by 0.04% to 100 basis points (1.00%).
  • Breakeven inflation rates increased slightly. The 10-year breakeven inflation rate increased 1 basis point (0.01%) to 1.76% last Friday. The 1.76% level is below the Fed’s 2% inflation target. Friday’s weaker than expected CPI, which fell from 1.9% in May to 1.6% in June, is weighing heavily on inflation expectations.
  • U.S. Treasury long positions remain elevated. The latest Commitments of Traders report, released by the CFTC (data July 14, 2017) shows that net-long bets in 10-year Treasury notes declined somewhat as traders sold into the higher prices. The net-longs are still elevated however.
  • Corporate spreads tighten. The option adjusted spread (OAS), which measures the yield differential between high-yield corporate bonds and comparable U.S. Treasuries, tightened from 3.73% to 3.63% on the week (based on the Bloomberg Barclays High Yield Index). Investment-grade corporates tightened as well from 1.11% to 1.09% on the week (based on the Bloomberg Barclays Investment Grade Corporate Index). Oil price stabilization is likely helping corporates to remain well bid.

Macro Notes

  • The lack of a pullback is global. As we noted recently, the max pullback so far this year for the S&P 500 has been only 2.8%. Should it finish the year here, this would be the second smallest pullback during a calendar year since 1950[1] (1995 is the record). Here’s the catch, other major global indexes have seen small relative pullbacks as well. This is very rare, as some of the smallest pullbacks ever for the S&P 500 have been accompanied by significant pullbacks in emerging markets and/or the Japanese Nikkei. Today, on the LPL Research blog we take a closer look at this phenomena and show just how rare the action in 2017 has been from a global perspective.

    [1] Please note: The modern design of the S&P 500 stock index was first launched in 1957. Performance back to 1950 incorporates the performance of predecessor index, the S&P 90.

 

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Tuesday

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