“Yesterday’s tech weakness, even if it just part of a healthy pullback in an extended sector, does set up a potential danger spot for stocks over the coming days,” says Tom Essaye of The Sevens Report, noting tech has powered stock gains this year even in the face of trade uncertainty.
Futures are slightly higher this morning after a very quiet night as global shares are edging higher after yesterday’s run to new all-time highs in several major US indexes.
Trade concerns continue to ease after yesterday’s favorable developments between the US and Mexico, leading to a further pullback in the dollar which has been the most significant tailwind for stocks over the last week.
Looking ahead to today’s session, there are a few notable economic reports due out: International Trade in Goods (E: -$69.4B), S&P Case-Shiller HPI (E: 0.2%), and Consumer Confidence (E: 126.8) but there are no Fed officials scheduled to speak.
Economic data aside, progress on trade and the subsequent decline in the dollar index have been the primary bullish influences on stocks right now, so as long as the trade situation doesn’t deteriorate today, and the dollar doesn’t materially rally, stocks should be able to continue towards new highs.
Futures are extending Friday’s gains following efforts by Chinese authorities to further strengthen the yuan.
The yuan strengthened to a one month high vs. the dollar as Chinese officials re-introduced the “Counter Cyclical Factor” in setting the daily value of the yuan. That “factor” is widely seen as an intent to ensure yuan strength and avoid a potential breach of 7.00. And, that support of the yuan is a potential macro positive.
The only notable econ report was German IFO Business sentiment, which beat estimates at 106.4 vs. (E) 105.4.
Today there are no notable economic reports and no important Fed speakers, so focus will remain on any trade headlines (a new trade deal with NAFTA seems imminent and that should be a mild positive on sentiment and stocks).
• Stock futures are cautiously higher today as the dollar continues to pullback on Trump’s comments about the Fed while investors have doubts about the new round of trade talks between the US and China.
• The dollar is down another 30 basis points+ this morning, extending its multi-session downtrend which should continue to act as a modest tailwind for stocks this week.
• British CBI Industrial Trends Survey was a mild miss at 7 vs. (E) 10 as Brexit concerns continues to weigh on sentiment.
• There are no economic reports or Fed speakers today.
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Below you’ll find six charts, spanning asset classes and economic data.
The charts are divided up into two groups.
Group 1 is comprised of four charts that explain why stocks have rallied so nicely in 2017, and why, in the near term, the trend in markets is still higher.
Group 2 is comprised of two charts that look into the future, and show that despite a bullish set up right now, there are real, serious reasons to be worried about how long this rally can last. Point being, these indicators are telling you not to be complacent!
Group 1: Why Stocks Have Rallied
Chart 1: Economic Data
Chart 2: Earnings Growth
Earnings and Economic Data – The Unsung Heroes of 2017
We have said since the early summer that an acceleration in economic data and earnings growth have been the unsung heroes of the 2017 rally.
And, as long as both of these factors continue to trend higher, that will underpin a continued rise in U.S. stocks, regardless of noise from Washington, North Korea, Russia, etc.
Chart 3: S&P 500
The Trend Is Your Friend
The trend in stocks has been relentlessly higher since early in 2016, and the S&P 500 has held that trend line through multiple tests.
Bottom line, the technical outlook on this market remains powerfully positive.
Chart 4: Commodities (Oil & Copper)
There are few better indicators of global economic growth than industrial commodities, and two or the most important (oil and copper) have been telling us for months that global growth is accelerating.
And, as long as oil and copper are grinding to new highs, that will be a tailwind not just on U.S. stocks, but on global stocks as well.
Group 2: Risks to This Rally
While the four charts above explain why stocks have rallied and why the outlook remains, broadly, positive, there are still risks to this rally and this market.
Don’t be fooled into being complacent with risk management, because while trends in U.S. and economic growth, earnings and the stock market are all still higher, there are warning signs looming on the horizon.
Chart 5: Inflation (Warning Sign #1)
Non-Confirmation: Why Isn’t Inflation Rising?
Inflation remains inexplicably low, considering that we’re near full employment and global economic growth is accelerating.
And, accelerating inflation remains the missing piece of a true “Reflation Rally” that can carry stocks 10%, 15% or even 20% higher over the coming quarters and years.
But, it’s not just about missed opportunity.
The lack of inflation is a big “non-confirmation” signal on this whole 2017 rally, and if we do not see inflation start to rise, and soon, that will be a major warning sign for stocks, because…
Chart 6: The Yield Curve – Will It Invert?
Yield Curve: Sending a Warning Signal?
If the outlook for stocks is so positive, then why did the yield curve (represented here by the 10’s – 2’s Treasury yield spread) equal 2017 lows on Wednesday?
Simply put, if we’re seeing accelerating economic growth, rising earnings, potential tax cuts and all these other positive market events, the yield curve should be steepening, not flattening.
So, if this 10’s – 2’s spread continues to decline, and turns negative (inverts) then that will be a sign that investors need to begin to exit the stock market, because a serious recession is looming, and the Fed won’t have much ammunition to fight it.
If I was stuck on a desert island (with an internet connection and access to my trading accounts of course) and could only have one indicator to watch to tell me when to reduce exposure in the markets, this 10’s – 2’s spread would be it – and it’s not sending positive signals for 2018!
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Looking to today’s CPI report, the preference here is for a slightly “Too Hot” number in headline and core CPI while a worst case scenario for stocks is a soft number, but keep in mind there will be impacts from the Hurricanes so the details in the report will be important.
Bottom line, I’ve said consistently for months that the only way I can see stocks moving materially higher is if they are driven by a reflationary rally. We got a glimpse of that in September, but for the reflation rally to continue, we need more Goldilocks data starting with today’s CPI.
Disconcertingly, if we don’t get that Goldilocks data, then the onus is going to be totally on earnings season to support stocks, and ensure this September rally doesn’t reverse. In that scenario, it’s an awful lot of pressure to put on continued growth in corporate earnings this late in an economic cycle.
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Last Week in Review
Economic data was mixed last week from a reflation standpoint, as growth data was a positive surprise while inflation data mildly disappointed. But, importantly, the inflation numbers weren’t enough to cause a reversal of the reflation trade or cause an unwind of the gains.
Inflation data remains the most important data point in the market, and Friday’s Core PCE Price Index was a mild disappointment. The August reading rose 0.1% vs. (E) 0.2%, while year-over-year Core PCE Price Index rose 1.2% vs. (E) 1.3%. That’s still well below the Fed’s 2.0% target, and it does somewhat undermine the strong CPI report—but it’s not the kind of number that would make the Fed think inflation is getting materially worse, and as such it didn’t cause a big move in markets.
Staying with inflation, the data was similarly underwhelming with the flash core EU HICP. It rose just 1.1% vs. (E) 1.2%, again sapping some of the positive momentum from the firm CPI data from earlier in December (Chinese, British, US). But like the soft Core PCE Price Index, it wasn’t a major market mover and it doesn’t undermine the fact that there are “green shoots” of inflation lurking out there, so it didn’t cause a pullback.
Looking at growth data, it was more positive. Durable Goods was the other important report from last week, and it handily beat estimates. New Orders for Non-Defense Capital Good ex-Aircraft rose 0.9% vs. (E) 0.3%, and the July number was revised higher to 1.1% from 0.4%. That number is important, because it implies that we’re seeing an acceleration of business spending and investment—and if that continues it will help create that economic “rising tide” that we need to help push stocks materially higher.
This Week’s Preview
For the remainder of the year, every week is an important one for markets as there will need to be constant reinforcement of virtuous reflation, but this week is more important than most given we get the global ISM PMIs and the US jobs report.
Starting with the latter, it’s jobs week, so we get ADP Wednesday, Claims Thursday, and the government report on Friday. We’ll do our normal Goldilocks preview later this week, but once again the wage number will be the key component of this release, and once again the risks are for a number being “Too Hot” and potentially recalibrating Fed rate hike expectations.
Beyond the jobs report, we get the global manufacturing PMIs (out later this morning for the US) and global composite PMIs (out Wednesday). Given the growing number of global central banks that are already removing accommodation (Fed, Bank of Canada) or are about to remove accommodation (ECB, Bank of England) economic growth data needs to stay firm to avoid a “stagflation” scare. So, Goldilocks numbers from both the manufacturing and composite PMIs this week will be welcomed by stocks.
Finally, turning to central banks, the minutes from the September ECB meeting will be released on Thursday, and investors will be searching for clues as to the severity and pace of the Fed’s taper. The
ECB usually plays things pretty close to the vest, so it’s unlikely we’ll see too much revealed in the minutes (they are going to do that at the October meeting), but the bottom line is any hints of extra hawkishness from the minutes could be a mild headwind on stocks this week. Bottom line, economic data in September helped spur a virtuous reflation rally, and that will need to continue this week if we’re going to see new highs in stocks.
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Durable Goods
• August Durable Goods rose 1.7% vs. (E) 1.5%.
Takeaway
Wednesday’s Durable Goods report was a surprisingly strong number, and if it’s the start of a trend in the data, then we could finally be seeing an economic reflation.
The reason the Durable Goods number was so strong wasn’t because of the headline (it was a mild beat, but revisions largely offset it), but instead because of the key New Orders for Non-Defense Capital Goods ex-Aircraft (NDCGXA). NDCGXA surged 0.9% vs. (E) 0.3%, and the July number was revised sharply higher to 1.1% from 0.4%, signaling that business spending and investment accelerated during the summer.
That’s a legitimately positive surprise, as business spending and investment have been lackluster so far in 2017.
But if we see that activity pick up (and importantly close the gap between actual data and survey data), then that will help push broad economic growth higher. And if inflation keeps accelerating, then we’ve got a legitimate reflation.
Stocks reacted accordingly to this surprisingly good data, as the market rallied (growth is good) and was led higher by our “reflation basket” of banks (KRE), industrials, smalls caps, and inverse bond ETFs. That carried through to other assets, as bond yields surged on the news to new multi-week highs while the dollar also broke above 93.00.
Bottom line, this was a legitimately positive surprise for markets, and stocks and the dollar/bonds reacted accordingly. However, one number does not make a trend, so we’ll need to see continued acceleration in other data (industrial production) before we can confidently say the gap between very strong, “soft” survey data and actual, hard economic numbers is closing in a bullish way. Still, yesterday’s number was definitely a good start.
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Starting at last week’s UN General Assembly, the war of words between US and North Korean leaders has been steadily escalating, but things got even more serious yesterday for two reasons.
First, the North Korean foreign minister said Trump had “declared war” on North Korea with his tweets.
Second, the same foreign minister said North Korea reserves the right to shoot down US bombers, even if they are not in North Korean airspace.
This is no doubt in retaliation to the US flying bombers very close to North Korea in a recent show of force.
Of the two statements, the later is much more important than the former for this simple reason: The
war of words can escalate, but the event that makes North Korea a bearish game changer for stocks would be the firing (but not necessarily striking) of a missile or rocket at anything US, including planes or Guam.
The North Korean threat to fire a missile at US war planes operating outside of North Korean airspace ups
the ante and creates another opportunity for a potential incident.
From a market standpoint, despite the uptick in tension, and despite yesterday’s mid-day dip, I don’t think the North Korean threat is going to cause a pullback, at least not in its current situation. Taxes (will we get cuts?), rates (will they rise?), inflation (will it gain momentum?), the dollar (will it appreciate?) all are much more important in the near term for stocks than North Korea.
But, that said, clearly this is something that can still move markets and dominate the headlines, so we’ll continue to watch it for you and look for signs of it legitimately becoming a bearish game changer for stocks.
For now, and until North Korea shoots at something US, the situation remains more bluster than bearish (although it still makes me uncomfortable).
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The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, leading indicators, seize opportunities, avoid risks and get more assets. Get a free two-week trial with no obligation, just tell us where to send it.
Assuming that North Korea is another temporary headwind on stocks (and again it will be temporary as long as they don’t shoot a missile at Guam), then the bigger story of the week is the outperformance of the cyclical sectors and the underperformance of YTD sector outperformers (super-cap internet, utilities, etc.).
I continue to believe that if we are going to see the stock market extend this 2017 rally, it will have to be driven by the expectation of an economic reflation. And, after months of lack luster inflation data, this week provided some hope for that cause. Now, today’s growth data needs to be better than expected to complete the week.
But, even then, one month does not make a trend—so I’m not saying abandon utilities, healthcare and super cap internet for banks and small caps. All I’m saying is that we need to be prepared to make a switch, if we get the compelling signals in the near future.
Regardless, the upcoming economic data (especially the Core PCE Price Index at the end of the month) just got a lot more important.
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