(Tuesday Market Open) Renewed hopes for progress in trade talks with China helped set a positive tone early Tuesday after Monday’s move higher. However, investors will have to wait to see if anything concrete lies behind this confidence.
Overseas markets appeared to share some of the optimism, as European and most Asian stocks marched upward overnight. In addition, crude oil is staging a rally, and would be up for seventh-straight day if it can remain higher throughout the session. Crude is often seen as a canary in the coal mine for the world economy, and its 30% descent last fall contributed to concern about global growth.
The government shutdown and trade talks with China look like they could continue to be the big fundamental features, at least until earnings season begins in earnest next week. Until then, geopolitics might be in the driver’s seat for a while. President Trump is scheduled to make a speech tonight about the shutdown.
Despite tension around China and Washington, markets do seem to be in a better place than they were back around the holiday. The S&P 500 (SPX) is now up about 200 points from where it was at the conclusion of trade on Dec. 24, a day some analysts now call the “Christmas Eve Massacre.” However, the SPX is still down 7% from its 200-day moving average of 2,741, and down 13% from its all-time high close posted just a few months ago. So things might feel a bit better now than they did right before Christmas, but we’re likely far from out of the woods.
Optimist Club
For those seeking positives, a couple of developments Monday conceivably could point to a more sunny time as the days grow longer. First, the small-cap Russell 2000 Index (RUT) led the other major indices (see chart below). The RUT fell more sharply than the SPX over the last several months, sinking into bear market territory. However, some analysts see the RUT as a leading indicator of market strength, so consider keeping an eye on that index to see if it continues to be a leader on the way higher. It’s already up 4.2% in just a few trading days so far this year.
On Monday, some of the top-performing sectors included ones that bulls typically like to see taking leadership, including consumer discretionary and energy. Visa (NYSE:V), Nike (NYSE:NKE) and Home Depot (NYSE:HD) all seemed to find some buying interest, while so-called “defensive” sectors like utilities and consumer staples lagged. In addition, the Nasdaq (COMP) outpaced the SPX, a possible sign of investors perhaps being more willing to embrace tech and biotech stocks that tend to perform better in strong economic times.
While we’re talking optimism, Tuesday’s NFIB Small Business Optimism report for December looked virtually unchanged from November, down just a smidgen.
Bears Still Appear to Outnumber Bulls
Another positive, besides the RUT and consumer discretionary out-performance, is that bearish expectations remain elevated. At this point, the ratio of bears to bulls is much higher than normal, according to market research firms, and historically that’s sometimes preceded better times for stocks. However, history isn’t necessarily guaranteed to repeat.
Meanwhile, the yield on the benchmark 10-year Treasury note continue to gain ground, climbing two points to 2.68% on Monday after falling well under 2.6% last week. With the underlying Treasury prices under pressure, it could potentially hint that some investors might be exiting more conservative Treasury positions to get back into stocks, but whether that’s a trend remains to be determined.
While there could arguably be some reasons to feel optimistic, the slowdown in economic data both in the U.S. and abroad continued Monday with the ISM Non-Manufacturing Index falling to 57.6% in December. While a reading above 50% is still a sign of expansion, the figure was down from 60.7% in November and failed to meet the average analyst estimate, according to Briefing.com. The report followed a downward reading in the ISM Manufacturing Index for December, and falling numbers in these reports could hint at a possible slow down in earnings growth.
One interesting note Monday was that despite the rally, the VIX (the market’s most closely-watched “fear indicator”) stayed pretty elevated. That might be an indication of trader nerves about tariffs and the Fed minutes due tomorrow.
More Data Ahead, Along With Fed Minutes
Fed minutes might be the key report to watch this week. These are from the December meeting, when the Fed raised rates despite a growing chorus of voices suggesting the Fed might want to stand back. The minutes could conceivably shed light on how the Fed reached its decision, which was unanimous, and what sort of factors the Fed saw that it felt justified the hike. The other thing to potentially look for is what participants might have said about the need — if any — that they might have seen for future hikes and what factors might cause them to raise rates again.
Later this week comes monthly consumer price index (CPI) data, along with earnings from Delta (NYSE:DAL). However, the bulk of earnings season doesn’t really get started until the big banks announce their Q4 results late next week.
Figure 1: More Aggressive Stance: It’s still really early, but this five-day chart shows that so far in the new year, some investors appear to be taking a more aggressive type of trade that embraces small-caps in the Russell 2000 (candlestick) and biotech and tech stocks in the Nasdaq (purple line). Both of these indices are doing better over this snapshot in time than the broader S&P 500 Index (blue line). Data Source: S&P Dow Jones Indices, FTSE Russell, Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Volatility Rings in New Year: If there’s been one constant over the last three months of wild market action, it’s arguably elevated volatility. The VIX started shooting up back in October and hasn’t made any signs of coming back toward 2018 lows since. It’s still above 20 despite a pullback so far in 2019. With China trade talks this week, followed by Fed minutes due tomorrow and then a speech by Fed Chair Jerome Powell, it’s not as if the market won’t lack potential news events that could bash the market around one way or the other. Of those three, the China talks might have the biggest impact on continued volatility, in part because the market tends to dislike uncertainty and no one is really sure what the rules are going to be on trade.
The last few weeks have seen severe ups and downs in the market, with two gains of 3% or more in the last seven sessions for the S&P 500 (SPX) heading into Monday. The indices plunge one day on fear, and then swing back the opposite way a day later on talk that maybe the selling was overdone. It wouldn’t be surprising to see this trend continue, despite a bit of a muted session on Monday, simply because so much is up in the air on the trade situation. A lot could rest on what level the tariffs ultimately reach. The higher they end up, the potentially worse impact on the market.
Shy and Retiring Fed? After several years of steady Fed rate hikes, the futures market makes 2019 look like the start of a new trend. Rather than predicting Fed action, the market now predicts Fed policy makers to stay on the sidelines. There’s almost no chance of a Fed hike in the first half, according to CME futures prices, and chances of even one hike before the end of the year currently stand at around 12%, down from approximately 50% just a month ago. In fact, there’s a much larger chance (the futures market indicates) of the Fed lowering rates by 25 basis points before year-end, with odds for a 25 basis-point drop in rates by December now seen at 15%. Just for historic perspective, the Fed hasn’t lowered rates since the 2008-09 recession.
Now this could certainly change depending on economic data, and it’s never easy to predict rate moves that are still months away. One question that lingers is whether the current Fed funds rate of between 2.25% and 2.5% is now the “new neutral” rate for the economy, meaning it neither stimulates nor hinders consumer and business economic activity. In the past, neutral was often seen as being higher than this, above 3%. However, with economies in China, Europe and Japan all struggling, the Fed might not want to push rates much higher and risk making U.S. products more expensive to consumers overseas already dealing with a relatively robust dollar. Higher rates can often contribute to dollar strength.
Counting Your Cows: Though the government remains partially shut down, that shouldn’t affect Friday’s release of consumer price data. We’ll preview expectations for that tomorrow. However, the shutdown is affecting release of agricultural data, which could have potential implications for some of the major firms in that arena like Archer-Daniels-Midland (NYSE:ADM) and Tyson Foods (NYSE:TSN). If agricultural economists can’t get data on things like how many acres of soybeans and corn farmers might plant and the size of the country’s livestock herds, it could potentially complicate decision making for some of the firms that buy commodities to process into food. Assuming the shutdown continues, it might be interesting to listen to some of the earnings conference calls from these firms to get a sense of how the lack of data might affect them.
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