By Pete Biebel, Senior Vice PresidentPrint This Post
All of Wall Street enjoyed watching as the stock market marched steadily higher through the fourth quarter of 2019. Then, last Thursday’s big gain on the first trading day of 2020 promised that the procession would continue. The high-stepping Technology sector was the drum major that lead the parade northward with most other equity sectors in lock-step, trailing behind. Stocks were responding to the drumbeats of Fed liquidity injections and signs of progress in trade talks with China. Even international equities in both developed markets and in emerging markets seemed to have regained some swagger in their step.
Then, Friday morning brought news of a U.S. airstrike in Baghdad that targeted and killed the leader of Iran’s Revolutionary Guard’s foreign wing. Equity markets around the world fell sharply on the news while flight-to-safety assets including Treasury Bonds and Gold spiked higher. The good news is that it could have been a lot worse. The major averages all hit their lows of the day in the opening minutes of trading. They all recovered about half of the opening loss and ended the day with losses of about three-quarters of one percent. They all gave back a big chunk of the previous day’s advance. The news on Friday that rained on the market’s march higher certainly dampened the mood, but so far there’s no indication that it was enough to halt the procession.
The major indices zig-zagged through the week like a Shriner in a tiny parade car. The market gapped-down Monday morning; it recovered a bit on Tuesday after hitting what would be its low of the week that morning; it ripped higher on Thursday on news that the Peoples Bank of China has loosened lending requirements. The major indices ended at their highs of the week that day. Then Friday it rained on the parade.
For the week, the NASDAQ Composite Index (COMP) eked out a gain of 0.16%. The Dow Jones Industrial Average (DJIA) and the S&P 500 Index (SPX) ended the week with minor net losses. It’s not often that SPX has a weekly loss that’s four times worse than that of DJIA. Last week, DJIA’s net loss was .04% and SPX plunged all of 0.16%.
Recent events have conspired to rain on the U.S. Dollar’s parade as well. The Dollar had been strutting higher for most of the first nine months of the year. But, since peaking about three months ago, it’s been trending lower and last week fell to its lowest level since midsummer. That Dollar weakness has been at least partially responsible for the recent uptrends in hard commodities like Crude Oil and precious metals.
Crude Oil spiked to a three-month high on the news of the attack. Crude hit a high near $64 per barrel in early trading, lifting it to within a couple dollars of its April 2019 high. Not surprisingly, higher Crude prices have put some pep in the step of the lagging Energy sector stocks. Where all other U.S. equity sectors had total returns of 20% or more in 2019, Energy returned only about 8%. But, since slumping to near its low of the year in November, the Energy sector has trended higher and, like Crude, is near a three-month high. It’s the most positive development for the sector in more than a year.
Friday’s news from Iraq, combined with the continuing weakness in the Dollar helped Gold forge its second consecutive sparkling week. Gold closed out the week just below its September 2019 intraday high and at its highest week-ending level since April of 2013.
SPX ended last week just below 3235. In my year-end commentary last week, I cautioned that the market was very extended on a short-term basis, a factor that will likely limit upside progress in the coming months. I also pointed to the strong upward momentum generated by the late-2019 rally and concluded that it greatly reduces the chances of seeing significantly lower index levels over the next few months. Over the next six to eight weeks, SPX would need to fall to near the 3000 level before any technical alarms would be triggered. I concluded, “The best bet seems to be for SPX to spend the most of first quarter of the year in the 3100 – 3300 range.”
Beyond the threat of increasing geopolitical tensions, one short-term source of concern for the stock market is the CBOE Put/Call Ratio. It’s a sentiment indicator that tracks the relative activity in bearish put options versus bullish call options. And, it’s a contrarian indicator; history has shown that when the indicator registers extreme bullishness, it’s often a short-term negative for stocks. When the indicator shows extreme bearishness, it’s usually a bullish sign for the market. The 50-day moving average of that ratio has dropped to its lowest level in nearly two years. In other words, the ratio is now showing extreme bullishness and has risen to levels not seen since the market top in January of 2018.
One longer-term source of concern is when and to what degree the Fed begins to drain liquidity. The Fed’s repo operation over the past several months was intended to bring stability to the overnight bank lending market, which it has. But, it also ramped up the size of the Fed’s balance sheet at the fastest rate and to the highest level in years. Everybody loves the parade float that dishes out candy along the route, but nobody likes it when the candy runs out. Over the coming months, the Fed must find a way to begin reducing its balance sheet without alarming the market.
This week brings a short list of economic reports and a long list of FOMC member speaking engagements. Those comments are likely to be scrutinized closely in search of any hints at a plan for balance sheet reduction. We’re in the midst of a relative drought of earnings reports, but we know that a downpour of reports is just weeks away when the new Earnings Season begins.
|Tuesday 1/7/2020||Balance of Trade, Trade Deficit||$47.2B||$43.5B|
|ISM Non-Manufacturing PMI||53.9||54.5|
|Factory Orders, M/M||+0.3%||-0.6%|
|Wednesday 1/8/2020||ADP Employment Report||+67K||+160K|
|Thursday 1/9/2020||Initial Jobless Claims||222K||220K|
|Friday 1/10/2020||Non-Farm Payrolls, M/M||+266K||+158K|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.