By Pete Biebel, Vice President

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All the major stock indices inched to new highs last week with the measured speed and grim determination of a French Quarter funeral procession.  To say the averages made a little movement would be like saying a glacier made a little movement today.  The S&P 500 Index (SPX) gained a whopping 0.15% for the week, but its entire range for the week, from its lowest low the its highest high was a mere 0.63%.  It was the third-narrowest week for SPX in the past 2 ½ years, and the only two narrower weeks were earlier this year.  The NASDAQ Composite Index (COMP) had a slightly larger gain (+0.24%) and a slightly wider range (0.83%).  The Dow Jones Industrial Average (DJIA) was, again, the big winner of the group, up 0.43%.

Over the past month or so, the market has seemingly been able to ignore the disruptive influences of natural disasters like hurricanes, earthquakes, wildfires and Congress.  Instead, its focus seemed to be on the potential for the passage of significant tax reform.  Messages from Washington that a real package of real reforms was really in our future inspired rallies in small-cap stocks and stocks of high tax rate corporations to lead the market higher in the preceding weeks.

More recently, as action on a tax plan has stalled, small-caps and high-tax companies have underperformed, and the market overall has lapsed into wait-and-see mode.  Traders are waiting for signs to tell them whether their strategies in anticipation of tax reform were well-timed or just wishful thinking.  The next big move in the overall market may well be driven by actual progress on a tax package or lack thereof.

The beginning of the new Earnings Season produced a bit of flatulence among some of the large banks that are traditionally early reporters.  Their results were generally less positive than expected and their share prices were subsequently deflated.  That left a cloud over the Financials sector which sagged 0.76% on the week.  While that loss made Financials the biggest loser last week, that sector still has, by far, the best five-week performance among the U.S. equity sectors with an 8.25% gain.

Also weighing on Financials were the resumptions of trends in declining interest rates and a flattening yield-curve.  In the preceding four weeks, the yield on the benchmark Ten-Year Treasury Notes vaulted from a post-election low near 2.03% to 2.40%.  In the five days of trading last week, that yield slid steadily lower and ended the week at 2.28%.  As a result, two interest rate sensitive sectors, Real Estate (+1.91%) and Utilities (+1.79%) were the biggest gainers last week.

An interesting side-note regarding Utilities is that the sector had a much larger gain through the first four days of last week.  On Friday, news suggesting one or more California utility companies might have some culpability in the California wildfires, sparked steep sell-offs in several large utilities with West Coast operations.  Those losses dimmed the otherwise high-voltage performances of the other stocks in the sector causing the group to give back about one-third of its earlier gain.

The one segment of market activity that might best reveal Wall Street’s expectations for tax reform is small-cap stocks.  The Russell 2000 Index (RUT) was the best performing of the broad indices into late-September.  It had gained well over 8% in the preceding five weeks as the prospects for lower corporate tax rates improved.  Since then, there’s been a noticeable decrease in movement.  RUT has gained just 0.8% net in two weeks, and last week RUT was the only major index with a net loss for the week.  Also last week, RUT had its narrowest range week in more than ten years.  In fact, last week’s range, about 0.8%, was nearly 30% narrower than the next smallest range, which occurred about 2 ½ years ago (1.11% in February 2015).

The next couple weeks should reveal whether the last two weeks’ action in small-caps is just a time-out or a top-out.  RUT can afford to give back up to 3% of its current value and still be above the late-summer highs.  If the damage gets much worse than that, if, for example, the attempts at tax reform stagnate, then it could mean that RUT has made an intermediate-term top.

Low volatility continues to be a prominent and ominous feature of recent market activity.  The CBOE Volatility Index, VIX, has been at record low levels and at low levels for a record length of time.  Perhaps the scariest feature of the market hovering near all-time highs is that it is overdue for at least a flash of volatility.

Last week I wrote “that even if the averages are able to advance at some point this week, it probably won’t be by much.”  I have the same expectation this week.  If the market finds an excuse to churn up some volatility, I suspect it’s more likely to take the averages lower than higher.  SPX ended last week just above 2553.  I’ll repeat what I wrote last week, “If the market does lapse into some sort of timeout phase, it could be as brief as just retracing half the recent gain.  If things get much worse than that, SPX should find substantial support around the 2500 level.”

As the pace of earnings reports picks up this week, folks at home might have some fun watching the relative performance of DJIA versus the other top indices.  Nine of the DJIA’s thirty component stocks are scheduled to release earnings this week.  Because the Dow is a price-weighted index, as opposed to capitalization-weighted, relatively small percentage moves in reaction to earnings news in any of the Dow’s higher priced stocks can create outsized moves in DJIA compared to other averages.  Four DJIA companies report tomorrow, one on Wednesday, and two each on Thursday and Friday.

 

Date Report Previous Consensus
Monday 10/16/2017 Empire State Manufacturing Survey 24.4 20.0
Tuesday 10/17/2017 Import and Export Prices, Imports, M/M +0.6% +0.5%
Import and Export Prices, Exports, M/M +0.6%  +0.4%
Industrial Production, Production, M/M -0.9%  +0.1%
Industrial Production, Manufacturing, M/M -0.3%  +0.3
Housing Market Index 64  64
Wednesday 10/18/2017 Housing Starts, SAAR 1.180mm  1.170mm
FOMC Beige Book
Thursday 10/19/2017 Jobless Claims 243K 240K
Philadelphia Fed Business Outlook Survey 23.8  20.2
Friday 10/20/2017 Existing Home Sales, SAAR 5.350mm  5.300mm
Existing Home Sales, M/M -1.7% -0.9%