By Pete Biebel, Senior Vice President

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Long-time readers might recall that I used that same title about four years ago.  Conditions then were unlike they are now; “unlike” as in diametrically opposed.  Back then, the S&P 500 Index (SPX) was hovering just above the 2000 level and the Fed was on the verge of its first interest rate hike in more than nine years.  The market had cratered about 7% in the three weeks prior after punching to near all-time highs in the previous weeks.  This time around the Fed is contemplating its first interest rate cut in more than ten years and stock indices just hit new record highs.  That prospect for a rate cut has been the key factor that has powered the averages higher from the early-June low.

The Fed’s dovish incantations over the past several weeks have been the equivalent to an “Applause” sign for the bulls.  Most of the market gains over the past month have come immediately following Fed comments, which continued to hint at a high probability of a rate cut announcement at their late-July meeting.  The bulls applauded each such announcement right on cue.  Following each statement, the averages soared, and the bears got buried.

Again, last week, the bears got “Fed-ed.”  After stalling just below the 3000 level in the previous week, SPX slid back to around 2975 on Monday and Tuesday in quiet trading ahead of the Fed chairman’s Congressional testimony midweek. Chairman Powell’s dovish cooings early on Wednesday lit up the bulls again.  Stock index futures, which had been deep in the red before the testimony, reversed to strong gains.  Stocks gapped higher that morning, lifting SPX to 3003.  That index bumped up against 3000 several times on Wednesday and Thursday but failed to close above that level both days.

A combination of factors including stronger euro-zone economic data, gains in overseas markets and hopeful comments on the U.S./China trade talks from Trump’s trade advisor, Peter Navarro, resulted in another gap-up opening Friday morning.  SPX gapped above the 3000 level and didn’t look back.  That big number barrier may have been the bear’s last line in the sand.  Stock indices trudged higher all day with the Fed-up bears no doubt throwing in the towel and covering shorts late in the session.  SPX finally managed to close above 3000, gaining 0.78% for the week to 3013.77.  The NASDAQ Composite Index (COMP) was up just over 1% for the week while the Dow Jones Industrial Average (DJIA) gained just over 1 ½% for the week.  All three indices ended the week at record highs.

Several other factors had significant impacts on individual market sectors.  The price of Crude Oil gushed 4 ½% higher on the week, climbing back above the $60 level for the first time since late-May.  Declining Crude inventories and the threat of production slow-downs in the Gulf (as tropical storm Barry approached Louisiana) contributed to the strength in Crude.  The strength in Crude contributed to solid gains in Energy sector stocks.  Energy led all of the S&P sectors last week with a gain of 2.22%.

Another factor that helped to pump up Crude and other commodities was weakness in the U.S. Dollar.  The Wall Street Journal Dollar Index was down three days in a row following the midweek Fed comments.

On Thursday, the Trump administration announced that it was dropping its proposal to eliminate rebates on government drug plans.  The proposal would have barred health insurers from continuing to receive rebates from drug companies on sales to Medicare patients.  The news was like a defibrillatory jolt to the stocks of companies in the medical plans and pharmacy benefit management businesses.  Those stocks, which had been more or less comatose for the past three or four months, spiked higher on the news and ended the week with healthy gains.  Unfortunately, many other healthcare stocks weren’t quite so chipper.  Pharmaceutical and Biotech stocks trended steeply lower through the week.  Of the 61 stocks in the S&P Healthcare sector, 40 had net losses for the week dragging the overall sector to a 1.44% loss for the week, worst of the U.S. equity sectors.

Despite the near promise of a Fed rate cut later this month, interest rates spiked higher late last week.  The yield on Ten-Year Treasury notes, which had dipped to their lowest levels in 2 ½ years in the prior week (1.95%), bumped up above 2.10% late last week.  Stronger economic news and higher than expected increases in CPI and PPI were blamed for the increase in longer-term rates.  The late-week spike in interest rates led to late-week weakness in the interest rate-sensitive Real Estate and Utilities sectors.  The S&P Real Estate sector lost about 0.2% for the week while the Utilities sector eked out a 0.02% net gain.

Another noteworthy performance, or lack thereof, was in small-cap stocks.  The Russell 2000 Index (RUT) has been lagging its big-brother indices for the past few months.  It’s only recently cleared its 200-day moving average and is still below not only its May rebound high, but also still well below its August 2018 all-time high.  I’ve been patiently waiting for RUT to display some relative strength in the hope that it would be a positive sign for continuing strength in the overall market.  Sadly, in a week in which the major averages all climbed to record highs, RUT had a net loss of 0.42%.

Whether the Fed will cause more pain for the bears will likely be determined this week.  The FOMC can’t say much more to convince the market that a rate cut is imminent.  The more likely catalyst in the week ahead could be earnings announcements.  This will be the first big week of quarterly reports in the new earnings season.  Analysts project that earnings will come in about 3% below their levels of a year ago.  That would mark the second consecutive quarter of earnings reductions.  However, those estimates are notoriously conservative.  For the first quarter of 2019, analysts expected a 4% decrease overall, yet the net decline was a mere 0.3%.

The next week or two should tell whether this is the beginning of a melt-up rally or the end of the line.  The market expects that a rate cut is coming in two-and-a-half weeks.  Surprise developments could come from news regarding the U.S./China trade war, the strength of the global economy or geopolitical developments in the Mideast.

In my commentaries over the past few months, I have written that I believed the market’s upside potential was fairly limited.  My guess was that SPX wouldn’t get much beyond 3025.  Friday’s close brought the index to within a dozen points of that level.  If SPX can climb much beyond 3025, then it would signal that we’re likely in the early stage of a melt-up rally.

Other than the relative weakness in small-cap stocks, there have been no big divergences to date threatening the strength of the rally.  Recall that there were several such divergences late last summer as the averages touched new highs prior to their fourth quarter meltdown.  The averages could afford to ease back a bit without doing any damage.  As long as SPX can hold above 2950 there should be no cause for concern.

As mentioned above, this week brings the first big week of the new earnings season; several big names in the Financials sector will be among the more prominent reporting companies.  Options expiration on Friday will bring a spike in volume though not necessarily in volatility.

Date Report Previous Consensus
Monday 7/15/2019 Empire State Manufacturing Survey -8.6  +0.5
Tuesday 7/16/2019 Retail Sales, M/M +0.5%  +0.1%
Retail Sales, less Autos & Gas, M/M +0.5%  +0.4%
Import and Export Prices, Imports, M/M -0.3%  -0.5%
Import and Export Prices, Exports, M/M -0.2%  -0.1%
Industrial Production, Production, M/M +0.4% +0.1%
Industrial Production, Manufacturing, M/M +0.2%  +0.2%
Business Inventories, M/M +0.5%  +0.4%
Housing Market Index 64  66
Wednesday 7/17/2019 Housing Starts, SAAR 1.269mm  1. 260mm
Thursday 7/18/2019 Jobless Claims 209K 214K
Philadelphia Fed Business Outlook Survey. +0.3  +4.5
Leading Indicators, M/M 0.0% +0.1%
Friday 7/19/2019 Consumer Sentiment 98.2 98.6

 

Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market