Market Update: Friday, August 25, 2017

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Yesterday’s Market Activity

  • Stocks mostly lower, finished near worst levels. Small caps outperformed (Russell 2000 +0.3%). Politics still in focus ahead of The Federal Reserve’s (Fed) Jackson Hole retreat. S&P 500 Index -0.2%, Nasdaq -0.1%, Dow -0.1%.
  • Healthcare the only sector gainer, biotech, pharma drove gains. Consumer staples underperformed; food stocks weighed. Energy held up relatively well with WTI crude oil -2.0% on the day.
  • Treasuries weaker across the curve, benchmark 10-year Treasury yield +2 basis points (0.02%) to 2.19%.
  • U.S. dollar up vs. yen, little changed vs. euro, pound sterling; COMEX gold (-0.2%) down again.
  • Initial jobless claims, existing home sales lower; claims below historical standards, expectations. Home sales -1.3% vs. +0.5% expected. Home prices +6.2% year over year (details below).

Overnight & This Morning

  • U.S. stocks moving higher ahead of much anticipated speeches from Fed Chair Janet Yellen and ECB President Mario Draghi at Jackson Hole.
  • Asian markets closed out the week on a positive note. Nikkei +0.5% following in-line Consumer Price Index reports. Hang Seng +1.2%, Shanghai Composite +1.8%.
  • European equities treading water mid-day. STOXX Europe 600 +0.3%.
  • Oil ($47.58/bbl.) up modestly, as oil producers shut down rigs ahead of Hurricane Harvey.
  • Industrials metals continue to outperform precious; copper +0.5%, gold unchanged at $1291/oz.
  • Treasuries flat, 10-year yield 2.19%.

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Key Insights

  • Market continues to focus on Jackson Hole. Given the lack of earnings news and the fact that Congress is not in session (and therefore there can be no real progress on issues like tax reform), it’s not surprising that the market is focused on Jackson Hole. Yet much of the decisions have already been made, the Federal Reserve (Fed) has told the markets, in great detail, what they are going to do, just not when. The European Central Bank (ECB) is in the opposite position. While they have not announced their actions, their choices are somewhat limited. They are almost certain to continue to purchase bonds next year, the only question is in what amount. This policy will likely be supportive of European equities, though the ultimate details will matter. And they must make an announcement soon, as their current policy will end in December of this year. And while today’s conference at Jackson Hole is taking place, the next scheduled meeting for both of these institutions is the most probable venue for major policy announcements.
  • Hurricane Harvey impacting oil and gas prices. The hurricane has snuck up to some degree on the markets, moving from a tropical storm to a category 2, and a possible 3 when it makes landfall later today. Oil prices initially rose on this news (as is typical as oil producers shut down rigs and cease new drilling during storms) but have since given back some of those gains. Gasoline prices are up, but this hurricane is likely to hit the heart of U.S. refining; and as these refiners shut down, this will result in a build-up of oil inventories, which leads to lower oil prices. This is unusual, but not unheard of. How long any additional oil glut will last will be a function of how long refiners are closed, which is impossible to predict at this point.

Macro Notes

  • Existing homes sales were weak, down 1.3% vs. expectations of +0.5%. Weakness was most pronounced in the Midwest and Northeast. However, median sales prices gained 6.2% on a year-over-year basis. The problem with housing continues to be weak supply. Fewer homes on the market results in fewer sales, but higher prices. At current rates, it would take a little over four months to clear all of the homes for sale; anything under five months is considered a tight market.
  • Stock market outlook (as of 8/18/17). With earnings season winding down and few potential market moving items on the calendar in the near term, markets may be more susceptible to risk from events such as budget and debt ceiling negotiations, a policy mistake by a major central bank, or rhetoric related to North Korea or other geopolitical hotspots. Given the potential for increased volatility, it may be prudent to take some risk off the table, though we do not believe the bull market is over and will continue watching for potential opportunities to buy dips. We continue to expect 6-9% returns for the S&P 500 in 2017, as stated in Midyear Outlook 2017 Outlook: A Shift In Market Controls, driven by: 1) a pickup in economic growth, 2) mid-to-high single digit earnings gains, 3) a stable price-to-earnings ratio of 19-20, and 4) prospects for a fiscal policy boost to earnings in 2018.
  • Bond market outlook (as of 8/18/17). We expect the 10-year Treasury yield to end 2017 in the range of 2.25-2.75%, with the potential for 3%. Scenario analysis based on this potential interest rate range and the duration of the index indicates low-to-mid single digit returns for the Bloomberg Barclays Aggregate Bond Index. We believe the Federal Reserve has begun to normalize interest rates in earnest and may hike one more time in 2017 assuming economic growth strengthens. Importantly, rising interest rates, along with a potential pickup in the pace of economic growth and inflation, may limit return potential.

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