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After Wednesday Wash-Out, Comeback Could Brew As Yields, Inflation Ease

By TD Ameritrade (JJ Kinahan)Market OverviewOct 11, 2018 12:06PM ET
www.investing.com/analysis/after-wednesday-washout-comeback-could-brew-as-yields-inflation-ease-200348061
After Wednesday Wash-Out, Comeback Could Brew As Yields, Inflation Ease
By TD Ameritrade (JJ Kinahan)   |  Oct 11, 2018 12:06PM ET
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(Thursday Market Open) The contagion that flared up Wednesday on Wall Street spread its wings and landed in Asia and Europe early Thursday, sending those markets down dramatically. Sharp losses in U.S. futures overnight hint at the chance for more declines as many investors appear to be in panic mode.

However, there were some signs early Thursday that the panic might be easing. Stock futures were coming off their lows and S&P 500 (SPX) futures actually entered positive territory as the consumer price index reading showed U.S. inflation rising just 0.1% in September and 2.3% year over year. The annual figure was down from 2.7% a month ago, and might speak to inflation pressures staying under control. Wall Street analysts had expected a 0.2% CPI rise for September.

The frenzied selling that took U.S. indices down 3% or more on Wednesday began amid worries about fast-rising Treasury note yields and potential inflation. However, by early Thursday, the benchmark 10-year yield was down to 3.18%, off eight basis points from the seven-year high posted two days ago. Yields fell as overseas markets crumbled overnight. Shanghai saw losses of more than 5%, and Tokyo experienced a nearly 4% drop. European indices fared a bit better, all down less than 2%, but hitting their lowest levels since early 2017.

The change of fortune in Treasuries, where prices are moving higher, suggests that a “flight to safety” trade which apparently started late yesterday could be continuing. Though no investment is truly “safe,” many investors tend to flock to Treasuries at times like these, perhaps in hope of a more conservative place to put their money. Other “defensive” areas like gold and the Japanese yen are starting to rise, as well. Gold is up more than 1% today.

Also, while the week seemed to start out as a sector rotation story in which investors were moving their money out of info tech and into areas like utilities and staples that are traditionally seen as more “defensive,” it’s hard to make that case now because every sector got hit. Some, like tech, have been hit worse than others, but none are unscathed.

The bloody battlefield after Wednesday’s session was littered with tech names as well as some like Facebook (NASDAQ:FB) that until recently were in tech but now dwell in the new “Communication Services” sector. Communication Services fell nearly 4%, while tech fell nearly 5%. Some of the major losses included Amazon.com (NASDAQ:AMZN) falling 6%, FB down 4%, and Netflix (NASDAQ:NFLX) down more than 8%. Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL) both fell sharply.

Profit taking might also be a factor. If you look at how far the market has come since the 2008-2009 financial crisis, it’s weathered one storm after the next and risen to lofty heights. Those storms includes the European financial scare of 2011, China’s slump in 2015-2016, and Brexit in 2016. So with the market still near recent all-time highs, it wouldn’t be incredibly surprising if people are just deciding to take money off the table. Concern that the trade situation with China might be getting worse, not better, along with the coming U.S. election, plus the uncertainty of the looming earnings season might be shaping some investors’ decisions.

Another factor could be that the U.S. market simply got too far ahead of markets in Europe and Asia, many of which have been flat or weak this year. Money poured into U.S. stocks and the dollar as investors sought places for growth, but perhaps we’re seeing a pause in that activity.

Bank Earnings Loom Friday

After Wednesday’s sharp sell-off, the stage is set for three major banks to report first thing Friday as JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC) all unveil results. The bank parade continues next week with Goldman Sachs (NYSE:GS), Bank of America (NYSE:BAC) and Morgan Stanley (NYSE:MS).

The financial sector is now lower for the year, with underperformance from investment banks and asset managers as well as many of the larger, diversified banks: GS, MS and WFC are all down in 2018.

While there have been a lot of positives for the sector, some analysts are starting to question how long the economy can grow at this pace, and how long corporations and consumers can maintain demand for loans. Rising interest rates have seemed to help the sector early this month, but it hasn’t escaped the selling pressure that put the entire market on its heels so far this week.

As always with big bank earnings, some of the factors to consider listening and watching for are trading volume, corporate lending strength or weakness, and executives’ take on the economy, interest rates, and consumer health. In Q2, if you’ll recall, JPM’s earnings generally impressed analysts, but WFC and C had mixed results. C struggled with fixed income trading, while WFC’s earnings and revenue came up short of Wall Street analysts’ estimates.

It’s likely that interest rates and Treasury note yields might get some attention in the earnings calls, either from the executives or from analysts in the Q&A. They might also be asked to comment on the psychology of the stock market after some panic seemed to grab hold of things late Wednesday.

Though the current market mood seems kind of dreary, remember that we’re heading into what looks like another strong earnings season, as well as awaiting the first government read on Q3 economic growth later this month. Those could end up being catalysts for investors looking beyond the interest rate story. At this point, many analysts still expect to see earnings rise around 20% in Q3, with revenues up 7%. Those would be strong numbers if they do show up, but we’ll have to wait and see.

Long-Term Investor? Some Thoughts on the Sell-Off

If you’re a long-term investor wondering how to protect your portfolio in these stormy waters, it’s a little easier if you’ve been paying attention all along and adjusting your allocations on a regular basis. For instance, the big rally in tech might have pushed your exposure to growth stocks up a little above where your comfort level. A mid-year or end of Q3 check-up and a rebalancing, if you did that, might have had you better situated to deal with possible downturns in the overall market like the one we’ve seen this week.

If you didn’t get around to that earlier, it’s still not necessarily a major issue. Yes, there may be some pain in the short-term, but it’s not too late to go back and re-balance. After all, the market isn’t down all that much from where it was at its peak, with the S&P 500 (SPX) down 5% from the Sept. 21 high after Wednesday’s plunge. Investors should be careful not to get paralyzed by fear at times like these, and not let greed be a driver, either. Most of the best investors don’t try to sell at the very top or buy at the very bottom (which is pretty much impossible, anyway), but do a lot of their trading in the middle.

The Communication Services Sector
The Communication Services Sector

FIGURE 1: Rough Start for Baby Sector: The Communication Services sector, which debuted last month and includes names formerly in tech like Facebook (FB) and Alphabet (NASDAQ:GOOG, GOOGL), isn’t exactly off to a sunny start. It fell 4% yesterday, with the tech sector (purple line) falling about 5%. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Watching Averages: Just like earlier this year when the market went into a slump, the moving averages below the major indices take on a little more importance for investors wondering when the pain might stop. Sometimes, though not always, the moving averages can represent technical support. That appeared to be the case last spring when the S&P 500 (SPX) took several drops toward its 200-day moving average but never made a big move below it, and eventually bounced back. Getting back to the current situation, the SPX took out its 20-day and 50-day moving averages within the first two hours of the session Wednesday, something that typically only happens when stocks get really slammed. The next major moving average is the 200-day, which is at approximately 2765. That’s also about the average SPX price for the year to date. This isn’t necessarily forming a safety net of any sort, but history suggests these technical points could be places where the index might make a technical stand of some sort, so stay tuned.

Dollar Nears Decade High Vs. Yuan: The dollar’s relationship with the Chinese yuan is drawing some attention this week and may be another factor weighing on stocks. By Wednesday, it took 6.92 yuan to buy a dollar, the weakest the yuan has been since last March. It’s been more than a decade since the yuan hit 7 per dollar, but Bloomberg reported Wednesday that the Chinese government may not step in to prevent that. The yuan has fallen 11% vs. the dollar since April.

Next week is a deadline for the U.S. to declare whether countries are manipulating their currencies, and one question is whether China will appear on that list. Treasury Secretary Steven Mnuchin told the Financial Times this week that the Trump administration is closely watching the yuan. A lot of investor money seems to be seeking potential shelter now in the U.S. dollar, perhaps seeing it as a bulwark amid continued international tension and trade worries, especially worries about the trade relationship with China. Turmoil in the Chinese market is one of a number of overseas developments that conceivably could derail the good momentum in the economy right now.

About These “High” Rates: One thing to keep in mind with the 10-year Treasury yield near 3.2% and seeming to spook the market: This level isn’t all that high historically. Back in the 1990s, during a historic stock market rally that lasted several years, the 10-year yield was mostly above 6%. Borrowing costs were also much higher than they are now during the rally of 2003-2007. The recent stock market weakness in the face of higher rates could reflect that yields zoomed up so suddenly after hanging out in a range between about 2.8% and 3.1% for months, and also could have sped up the shifting sands we mentioned yesterday in which investors start rotating out of tech and some other sectors that have been driving the long rally. This kind of sector rotation might reflect a “tipping point,” according to some analysts, more toward value stocks and away from growth. That’s one theory, anyway. The counter-argument is that it seems a bit too soon to make broad predictions based on one bad week with the broad market still only 5% below all-time highs.

Good Trading

After Wednesday Wash-Out, Comeback Could Brew As Yields, Inflation Ease
 
After Wednesday Wash-Out, Comeback Could Brew As Yields, Inflation Ease

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