Fed Week To Dawn With Market Racking Up New Highs, Steeled For Possible Hike

It’s Fed Week on Wall Street and futures prices show a very strong chance of a rate hike, the third of the year. A key earnings report and inflation data also are in the works.

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Key Takeaways

  • The Fed meeting takes center stage in the coming week, with futures showing strong chances of a hike

  • Nike (NKE) earnings after the close Tuesday could send signals about the consumer


  • Stocks set new record highs last week as economic data continue to look strong

(Monday Pre-Market) Powell and company ride again this coming week.

The Fed takes the spotlight Tuesday and Wednesday in a meeting that investors widely expect to result in another rate hike, the third of the year. Fed Chair Jerome Powell has made it clear he believes the Fed should continue gradually raising borrowing costs, and the futures market appears to buy what he’s selling. As of Friday, CME futures placed rate increase odds at around 94%. 

Since the Fed usually does such a good job readying investors for a hike, the question is more around what might emerge from the post-meeting release and Powell’s Wednesday press conference. Investors are likely to be on the edge of their seats waiting to hear Powell’s views on inflation and wage growth, and what he says could help shape expectations for future rate moves not just in 2018, but increasingly looking into 2019 as well. In one signal of expectations ahead of the meeting, 10-year Treasury yields rose to 3.07% as of midday Friday after a solid rally from levels down near 2.8% a month ago.

Connect the “Dot”

The Fed has been raising rates pretty regularly since late 2015, and if it does so again this week it would put the target rate between 2% and 2.25%, the highest level since the Great Recession of 2008-09. At this point, futures prices forecast a better than 80% chance of a fourth 2018 hike by end of year, and greater than 50% odds of another one to follow in March. If that scenario takes place, it would put the Fed’s benchmark rate at between 2.5% and 2.75% by next spring. The question from there might be whether the Fed would want to go higher, especially with rock-bottom rates still holding in much of the developed world. The so-called “dot-plot” of Fed officials’ predictions for 2019 and 2020 rates could get a lot of attention this time around as investors try to sense how far the Fed might be willing to go.

For investors, “Fed Week” can seem like a waiting game, especially the first few days. Traditionally, the market tends to move slowly on Tuesday and early Wednesday while people await the Fed decision. Then it can sometimes be a wild ride Wednesday afternoon as the Fed’s words and actions get digested. 

Long-term investors should consider giving the dot-plot a close look, because if it seems more hawkish, it could mean tougher sledding for the stock market over the longer haul. That doesn’t mean anyone should make any knee-jerk trading reactions based on what the Fed says, only that it’s important to study the Fed’s predictions and try to determine if your investment strategy needs any tweaking based on the Fed’s outlook. Higher rates historically tend to be bearish for dividend names in utilities and staples, for instance.

Will Weakness Overseas Eventually Clip U.S. Market?

When you look at why so many investors expect rates to keep rising, it’s mostly due to good news. Strong economic growth, low unemployment, and rising wages all have the Fed working to get ahead of the curve and try to keep inflation from flaring up. These are positive developments, so even if higher rates potentially clip the stock market, things are arguably moving in the right direction from an economic perspective. As we noted last week, the concerns are chiefly overseas, where Europe, China, and Japan are all struggling and rates in Europe and Japan remain extremely low. 

All that said, emerging markets did seem to revive a bit toward the end of last week, with investors appearing enthusiastic about the International Monetary Fund’s (IMF) financing arrangements with Argentina. Turkey remains a wild card, however.

Looking beyond the big macro issues for a minute, the week ahead brings a smidgen of corporate news as Nike (NKE) reports after the close Tuesday (see more below). However, the start of earnings season remains far off, meaning that headline geopolitical and economic events are likely to remain the focus barring some major corporate news development.

Fresh Batch of Data On the Way

The new week doesn’t suffer from any lack of numbers. Some of the key data include August new home sales, August durable goods, the government’s third and final estimate for Q2 gross domestic product (GDP), and Personal Consumption Expenditure (PCE) prices for August—which are among the inflation numbers most closely watched by the Fed.

Stocks start the new week coming off of fresh record highs for the S&P 500 (SPX) and Dow Jones Industrial Average ($DJI). The new peaks occurred as tariff fears receded and economic data continued to look mostly strong. However, crude oil prices keep rising, and that’s something to perhaps watch carefully in the weeks ahead. Some corporate leaders have expressed concern that higher energy costs could start to clip margins. They’re also worried about the strong dollar, though the dollar’s retreat over the last few weeks might be easing those concerns a little.

New Sector Debuts

There’s also a whole new twist this week with the debut of the Communication Services sector. It replaces the old telecom sector and pulls in a bunch of familiar names from tech and consumer discretionary, including Facebook (FB), Netflix (NFLX), Alphabet (GOOG, GOOGL), CBS (CBS), Disney (DIS), and Twitter (TWTR), among others. It will still include telecom bellwethers AT&T (T) and Verizon (VZ). 

The new sector is likely to bring a somewhat different feel to the markets, with tech no longer getting so much influence from GOOG and FB. There’s no predicting how things might go in the long run, but conceivably communications could be a livelier sector than the somewhat moribond telecom sector, which was really more of a dividend player’s game than anything else, with just three stocks. 

Figure 1: Summer Memories: Volatility, as measured by the VIX, is back down near summer lows even as earnings, a Fed meeting, and the November election approach. Meanwhile, 10-year yields (purple line) continue to rise amid expectations for another Fed rate hike. Data Source: Cboe, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Summer Doldrums for VIX? Summer officially ended last Friday, but the last few days brought beach weather in Chicago and maybe that’s why the CBOE’s VIX is acting like July never ended (See Fig. 1 above). Typically, though not always, VIX eases a bit in summer months when markets tend to be less volatile. That was definitely the case in 2017, when VIX fell to historic lows below 10. However, it’s was up and down this summer, and never tested last year’s lows. VIX is still up for the year, but traded down at around 11.2 by midday Friday, not far off lows just below 11 last seen in early August. The interesting thing is to watch VIX falling even as a Fed meeting looms this week and at a time of year when it often rises. One possibility is that people might be less concerned about trade battles. However, sometimes a low VIX can turn around quickly, so investors might not want to get too complacent, especially with all the events on the horizon (Fed meeting, earnings, midterm elections).

Not Playing Defense: Some of the major defense-related companies like Boeing (BA), Lockheed Martin (LMT), and Raytheon (RTN) got boosts in 2017 when the new U.S. administration came to Washington, D.C. with a heightened focus on military spending. Though shares of the three have flatlined a bit this year, partly on tariff fears, things got a bit livelier last week. BA came close to highs it made earlier this year, and LMT has come back a long way from its July lows. The U.S Senate’s approval last week of a $674 billion defense bill might explain part of the recent rally, and U.S. allies are also boosting their defense budgets. BA also has seen strong commercial aircraft demand, analysts said. One caveat might be the coming U.S. election, however. Any potential for possible Washington policy changes would probably get a close eye from investors in this industry.

Taking Wing: Want a challenge? Try to name the best-performing stock so far this year in the Dow Jones Industrial Average ($DJI). Some might be tempted to say Apple (AAPL), Boeing (BA), Microsoft (MSFT), or Cisco (CSCO). While all of those names have big 2018 gains, the answer is actually Nike (NKE), which was up more than 36% year-to-date through midday Friday. 

NKE comes into the spotlight Tuesday when it’s scheduled to report after the close. Last time out, back in late June, NKE shares climbed sharply after the shoe and apparel giant reported stronger-than-expected earnings and revenue and said it had returned to sales gains in North America. The company also announced a $15 billion stock buyback plan. One question that might loom large for NKE this time around is whether sales might have gotten a boost or a shove from its controversial recent ad strategy. Stay tuned.


Good Trading, 

JJ

@TDAJJKinahan 

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