by Pinchas Cohen
The Week That Was
Stocks were mixed during the past week, underscoring investor preference. The rotation out of Technology continued, yet even after last week's selloff the sector still outperformed versus the S&P 500 Index. The Technology sector is currently up 30.89 percent, almost twice the 17.45 gain of the benchmark index. And even during a losing week, tech shares eked out a 0.15 move higher.
As well as tech shares being considered expensive at this point, technology firms provide investors with a negative relative value in the face of possible corporate tax cuts, the biggest initiative on Trump's current agenda, which appears to be on course. The proposed tax rate of 20 percent leaves out technology companies, whose average effective rate is already at 18.5 percent.
Though the biggest asset class beneficiaries are seen to be domestic small-cap companies, whose effective tax rate is 32 percent, the Russell 2000 lost 1 percent this past week.
The biggest sector beneficiary, Financials, which have the highest effective tax rate among larger caps, of 27.5 percent, outperformed, up 1.56 percent. Much like the Russell 2000, the information technology heavy-NASDAQ Composite declined last week, albeit less than the small-cap index, falling just 0.10 percent.
The Dow Jones Industrial Average gained 0.40 percent, and the S&P 500 Index gained 0.35 percent. Both indexes achieved a record close on Friday. For the S&P 500 it was the 57th record of the year.
In addition to tax reform buoying the market recently, the economy has been surprisingly cooperative. Friday's Nonfarm Payroll release showed 228,000 new jobs were created in November, exceeding the forecasts. Of even greater importance—and also the biggest potential challenge to economic expansion—average hourly earnings grew 2.5 percent annually, accelerating from the 2.3 percent rate seen during last month’s report.
Economists suspect that diminishing wage growth is the reason for inflation’s inability to pick up steam. That’s understandable, considering a developed economy relies on consumer spending for economic growth. Naturally, the more expendable income available to consumers, the more they’ll likely spend.
While inflation growth is promising for economic progression, it nevertheless remains modest. Therefore, it is unlikely to accelerate the Federal Reserve’s interest rate hike trajectory in the coming year. Rather, markets expect the US central bank to stay the course—including this year's third rate hike in the coming week—as well as shrinking the balance sheet since inflation has been rising from midyear lows, even as the labor market remains robust and GDP has been coming in at higher than 3 percent during the past two quarters to boot. All told, and compared to the more sluggish numbers seen previously, these paint a picture of economic health, egging on equity bulls.
We can’t help but notice that when juxtaposing the two catalysts, fiscal policy and economic growth, they have occurred in reverse order. While tax cuts have yet to materialize—and investors have no idea what the final bill might actually look like—economic growth has already happened. In other words, we don’t know that fiscal policy will in fact continue to prop up historically high market valuations, just as we can't predict that the economy will continue to grow at its current pace.
During the past three months small-caps outperformed, as the Russell climbed 9.6 percent versus the S&P 500's 6.99 percent. It's worth noting that traditionally, small caps outperform at market tops, as investors' growing appetite makes them more and more speculative. Of course, the market narrative currently says something else entirely: the outperformance was driven by the potential gains from corporate tax cuts. So why then, in the week after the Senate passed its tax bill, did the Russell 2000 drop by a full percent?
Bitcoin futures trading begins this evening, at 6PM Eastern via the CBOE (NASDAQ:CBOE). The volatile cryptocurrency has nearly doubled in price since the start of December, reaching just past $19,000 per coin on Thursday on some exchanges before plunging lower by more than $3,000 on Friday. Will Bitcoin futures trading crash markets or capture $10Billion in trade as some are predicting?
The Week Ahead
All times listed are in EST
Currency traders will enjoy a target-rich environment this coming week. The Federal Reserve announces interest rates on Wednesday, while Thursday offers a central bank policy meeting trifecta: the Swiss National Bank, European Central Bank and the Bank of England all meet. The week will close with a Russian interest rate decision on Friday.
Monday
10:00: US – JOLTs Job Openings (Nov): the previous read was 6.093M
Tuesday
4:30: UK – CPI (November): expected to rise to 3.1% YoY from 3%, and 0.2% MoM from 0.1%. Core CPI expected to increase to 2.8% from 2.7% YoY.
5:00: Germany – ZEW index (December): economic sentiment forecast to fall to 16 from 18.7. Market to watch: EUR crosses
8:30: US – PPI (November): forecast to hold at 0.4% MoM.
18:30: Australia – Westpac Consumer Sentiment (December): expected to fall to 97 from 99.7.
Wednesday
4:30: UK – Employment data: October unemployment rate to hold at 4.3%, while claimant count rises by 2300 in November from 1100 in October. Average earnings expected to rise by 2.1% in October from 2.2% in September.
8:30: US – CPI (November): expected to hold at 2% YoY and rise to 0.3% MoM from 0.1%, while core CPI expected to weaken to 1.7% YoY from 1.8%.
10:30: US – EIA Crude Inventories (w/e 8 December): stockpiles forecast to rise by 1.7 million barrels after rising by 6.8 million a week earlier.
Last week, the price of oil completed a second consecutive weekly decline, its first since July-August, when it completed five consecutive weekly declines. This second weekly slide follows the 37-percent rise between the week ending June 19 and the week ending November 20, its biggest upmove since the 67 percent advance between the week ending February 8 and the week ending May 23, 2016. After reaching the top of its bearish rising wedge, will it repeat the same behavior as the 15 percent correction between may 23 and July 25?
14:00: US – FOMC Interest Rate Decision and Statement (press conference 7:30pm): The Fed is expected to raise rates to 1.5% from 1.25%. Watch out for additional commentary on future policy and comments on the winding down of QE purchases.
Considering this will be Janet Yellen’s last meeting, as a lame duck it is unclear how much impact her press conference will have on investors. Still, the USD could move higher after the fact. Presumably, she wouldn't project a path that would deviate from the one Fed Governor Jerome Powell intends to lead through...but we shouldn’t presume.
19:30: Australia – Employment data (November): unemployment rate forecast to rise to 5.5% from 5.4%, while employment change is forecast to see 19,200 jobs created from 3700 a month earlier.
19:30: Japan – Manufacturing PMI (December, flash): expected to drop to 53.2 from 53.6.
21:00: China – Retail Sales (November): forecast to rise 10.2% YoY from 10%.
Savvy investors familiar with intermarket analysis will keep a close watch on the rate of economic growth for the second largest global economy. They understand that when China cools down, major commodities sell off, weighing on equities worldwide.
Thursday
3:30: Germany – Manufacturing PMI (Dec): expected to drop to 62.2 to 62.5
3:30: Switzerland – SNB Monetary Policy Assessment
The recent Swiss franc weakness helped curb its overvaluation, making it highly unlikely policy makers will raise rates from the current, 0.75 percent, since the Swiss currency is still highly valued. As well, it's widely assumed they'll raise rates before the ECB will.
4:00: Switzerland – SNB Press Conference
4:30: UK – Retail Sales (November): forecast to fall 0.6% from 0.3% YoY, and rise 0.1% from 0.3% MoM.
7:00: UK – BoE Rate Decision
Considering the mess the UK is in, with uncertainty over Brexit, wage growth that isn't keeping up with rising inflation due to the higher cost of exports on a weaker pound in the aftermath of Brexit and low productivity, it’s unfathomable that policy makers would raise rates. And even though sterling is on an upward trajectory, it's still 10.75 percent weaker than before June 2016's Brexit vote. In fact, consensus has it that no further hikes would be forthcoming before the end of next year. The only think GBP bulls can hope for is hawkish commentary to lift Cable along with their moods.
7:45: Eurozone – ECB Rate Decision (8:30 Press Conference)
The central bank is expected to leave policy unchanged. Since ECB President Mario Draghi is expected to vow support for the economy by maintaining extremely low rates in the foreseeable future, that leaves investors awaiting comments on any change to QE, which might send the euro into a frenzy. Naturally, even rhetoric on foreseeable rate changes should create massive volatility for the euro. And as the greenback’s biggest currency partner, for the dollar as well.
8:30: US – Retail Sales (November), Initial Jobless Claims (w/e 9 December): retail sales expected to rise 0.3% MoM from 0.2%, while 236K claims expected. Markets to watch: US indices, USD crosses
9:45: US – Manufacturing and Services PMI (December, flash): manufacturing PMI forecast to rise to 54.1 from 53.9, and services PMI to hit 55.2 from 54.5.
Friday
5:30: Russia – Russian Interest Rate Decision (December):
The Bank of Russia is expected to reduce interest rates to 8.00 percent from 8.25 percent which could have a positive affect on the ruble.
8:30: US – Empire State Manufacturing Index (December): forecast to rise to 26 from 19.4.