Sleep Late This Morning? You Might Have Missed the Break Before the Rally

After digesting a little bearish inflation and retail sales data just before the opening bell, the market recovered to post a fourth-straight day of solid gains.

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(Wednesday Market Close) If you slept in this morning, congratulations. You might have missed the big Wall Street drama of the day. After digesting a little bearish inflation and retail sales data just before the opening bell, the market recovered to post a fourth-straight session of solid gains.

Judging from the market’s quick rebound Wednesday after stocks fell in pre-market trading following the data, it looks like many investors might have taken a second glance at the numbers and decided not to freak out after what now looks like an initial over-reaction. Perhaps people realized that the January consumer price index, which rose 0.5% to top Wall Street analysts’ expectations, represented just one point in time, not necessarily a new trend. The same could be argued for January retail sales, which came in below expectations. 

If that’s the case, then arguably emotions have really flipped in just the last week. Worries about inflation and possible higher interest rates ganged up on stock markets around the world a week ago, but today — with actual data showing a climb in inflation and yields in the interest rate complex posting new four-year highs — stocks rallied. The benchmark 10-year yield traded at 2.91% by the end of the stock market session Wednesday. A week ago the yield hit 2.885% and from the market’s reaction, it seemed like the sky was falling. Today, people seemed to shrug off 2.91%.

All that said, there’s no reason for investors to think things are back to how they were before the deluge earlier this month. Though past isn’t precedent, history suggests these sort of volatility surges tend to last about three weeks, and we’re only midway through week two. We could have another week of volatility coming. The market might have over-corrected to the downside earlier this month, but there’s also a risk it could over-correct to the upside now. That means investors who bought shares back near the lows and have seen those stocks go up 8% or 9% might want to study their gains and see if they might have already met their price goals. 

Speaking of volatility, the VIX fell back below 20 Wednesday for the first time since all the craziness began. It could pay to be cautious, however. Volatility screamed up and stocks plunged in a very compressed timeframe, and that was abnormal. It would also be abnormal if stocks keep climbing now without volatility after what they just went through.

In the aftermath of today’s explosive upsurge, it’s interesting to look back on where the market has been. Back on Feb. 9, just last Friday, the S&P 500 (SPX) hit an intraday low of 2532.69. That was the weakest level since early October, and marked a nearly 12% decline from the Jan. 26 all-time high of 2872.87.

By late Wednesday — just four sessions after hitting that low point — the SPX climbed briefly back above 2,700 before finishing just below that round number. That’s up nearly 7% from Friday’s bottom, but still a long way from the Jan. 26 high. Basically, in those four days, the SPX has charged back from being at the level it was in early October to reaching a level it first hit in early January of this year — 2,700. Three months in four sessions.

Leading sectors included ones typically associated with growth in the economy. Financials led the charge Wednesday, climbing more than 2%. That could be viewed as constructive, because quite often the financial sector can help set the tone for the rest of the market. Info tech rose nearly 2%, with big gains for companies like Netflix (NFLX) and Amazon (AMZN). Those were two of the names that helped set the positive mood in December and January, and now they seem to be coming back.

From a broader perspective, things played out today more along the lines you might expect based on historical patterns. Stocks rose as bond prices fell. Crude oil got a big lift as the dollar retreated slightly.

Yes, the inflation number this morning was a little higher than expected, but it isn’t too surprising when you consider the bigger picture. The economy is growing, and that tends to sometimes push inflation and interest rates up. Higher interest rates often signal a stronger economy.

A week ago, many economists looked for the Fed to raise rates three to four times this year. Today, the numbers confirmed what had been thought, meaning probably we can expect three to four rate hikes. Everything people had thought would happen seems to be happening, and cooler heads appear to be prevailing on Wall Street.

However, the takeaway is still not to get overly complacent. Volatility hasn’t necessarily gone into hibernation.

S&P 500 Futures Pre-Open 2-14-18

FIGURE 1: HEAD FAKE?

Futures on the S&P 500 (/ES) took a wild ride this morning, mostly before the open, as soft retail data, combined with a higher-than-expected CPI reading, sent markets down before quickly climbing back. Data source: S&P Dow Jones Indices, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Good Trading
JJ
@TDAJJKinahan

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