Wednesday begins with stocks trying to follow through after a late rally Tuesday, with small caps, Financials, and the venerable Dow Jones Transportation Average making advances. Also, the yield on 10-year Treasuries starts the day around 1.75%—well off last week's low around 1.45%.
Follow-through potential eyed after late rally yesterday
Bonds remain under pressure
China allows some exemptions on tariffs
(Wednesday Market Open) If today has a theme, it could be “follow-through.” The question going in is, can stocks pick up on the momentum where they left off late Tuesday?
Though stocks were down most of the day yesterday, they clawed back to close around flat and near the day’s highs, with the Dow Jones Industrial Average ($DJI) now up five days in a row and going for a sixth today. Sometimes you see that kind of late-day action roll into the next session, especially on days like today when other news is kind of thin. There’s no guarantee, though.
If stocks do get a boost, it will likely be in sync with a bond market that remains under pressure. Ten-year Treasury yields climbed to 1.75% this morning after being below 1.5% just over a week ago. It’s been a huge sell-off for Treasuries (which move the opposite direction of yields) over the last week. That could reflect more hopeful economic prospects or could be more of a technical thing considering the massive rally they’ve had.
Weakness in bonds might bode well for Financial stocks again today, so we’ll see if they can help lead the way.
The other theme today might be sector rotation (see more below). Over the last two sessions, small-caps did an about-face and finished much higher than the rest of the market after lagging all summer. Strength in Energy and banking stocks, both well represented in the small-cap space, played a role. This could be a positive sign, because when you see small stocks gain it often reflects a solid domestic economy. The Russell 2000 (RUT), which had been in correction territory, posted a five week high yesterday and it’s encouraging to see them start to get some traction.
The other thing the small-cap rally might be telling us is that investor caution could be fading slightly. People appear to have plenty of pent-up demand to buy stocks, but they’ve been cautious to get in. Now, with the RUT having suffered the most, it looks like people are starting to put some money there. Still, it’s likely everyone will continue to be cautious through next week’s Fed meeting.
Meanwhile, on the trade front, China has suspended 16 types of U.S. exported goods from import tariffs ahead of the latest round of trade talks, The Financial Times reported. Starting Sept. 17, China will for one year suspend the tariffs, which include some cancer drugs, lubricant oils and some chemicals. This news appeared to help give stocks a lift in pre-market trading, maybe raising hopes that the two countries’ relationship is thawing a bit as the talks loom. The market appeared to have a muted reaction to the China news.
Reaction was also a bit quiet to inflation numbers this morning, though producer prices (PPI) did rise more than expected in August. The headline monthly change of 0.1% was in line with the Briefing.com consensus, and prices rose 1.8% year-over-year. However, core PPI, which strips out volatile food and energy, rose 0.3% after falling in July. Analysts had expected 0.1%. The core number looks a bit stronger than projected, but one month isn’t a trend and it seems unlikely that this report would have too much impact on whatever the Fed ends up doing next week. Consumer prices are due tomorrow.
Anyone looking at market action on Tuesday might assume sellers dominated. That’s not necessarily a wild leap of the imagination, considering the S&P 500 Index (SPX) spent most of the day lower before a flat close. But there could be other forces at work as well.
What appears to be happening, instead, is rotation. That is, investors could be moving out of some of the hottest parts of the market—namely Technology—and into some under-appreciated areas. These include Financials, Energy, small-caps, value stocks, and retail sector stocks. All of these groups have underperformed for a long time, and one day is never a trend. If this kind of trading continues, though, it could mark a significant shift in market behavior.
It looks like some investors might see these beaten-down sectors as potential value plays. That’s helping the small-cap Russell 2000 Index (RUT), which surged nearly 1% Tuesday to easily outpace the SPX. The RUT is heavily populated by regional bank stocks, which got a big lift. Financials across the board are plowing higher as Treasury yields popped.
Those same higher yields appear to be hurting a trade that was popular over the last few weeks, where investors clamored into dividend-paying stocks like Utilities and Real Estate. Those sectors often serve as barometers for the bond market, and when yields start moving back up, the dividends those sectors pay might seem a little less enticing to some investors.
Real Estate could also be getting a fish-eye from some investors as the WeWork initial public offering (IPO) remains in question amid projected valuations continuing to track lower. Initial reports put the expected IPO at around $47 billion, but recent projections put the valuation closer to $20 billion, according to The Wall Street Journal.
Technology—still the leading sector year-to-date—was one of Tuesday’s worst performers, and we’ll have to see if there’s follow-through on that today. The FAANG names spent much of Tuesday under pressure, though Apple (AAPL) managed to post gains on the day it introduced its new iPhones. The phones, by the way, didn’t hold a lot of technological surprises, one analyst told the TDA Ameritrade Network. Instead, it looks like AAPL is continuing to stress bigger and faster, with no surprises like a 5G phone. The phones introduced yesterday might be seen as an interim step ahead of 5G the next time around.
AAPL’s announcement of Apple TV+ for $4.99 a month appeared to weigh on shares of competitors Disney (DIS) and fellow FAANG member Netflix (NFLX), analysts said. Other FAANG stocks may be under pressure from continued headlines about government investigations into privacy and antitrust concerns.
If rotation out of the year-to-date hit list is truly happening, why now? Maybe one reason could be the big jump in Treasury yields that put some of the “defensive” sectors under a cloud early this week. It could also be that there’s only a few weeks left in the quarter and fund managers might be taking profit on some winners before sending out the quarterly reports to clients.
Another less thrilling prospect is that this is the same sort of rotation into value-type names that we saw last October before the market took a major spill. The FAANGs got hit then, too.
On the other hand, Briefing.com said the rotation could reflect optimism about economic growth and trade. For instance, the Dow Jones Transportation Average ($DJT) rose 1.5% on Tuesday, and often does well when investors are optimistic about the business climate. Transports had been lagging since mid-July but are now just 3% below their 2019 high.
Issues like Brexit, China trade, tension around the next Fed move, and global economic slowing haven’t gone away, but with Cboe Volatility Index (VIX) dipping to 15 early this week it appears investors might be a bit more willing to take things in stride. It probably helps that there’s more optimism around trade talks than there was, say, a month ago, but as we’ve noted, the market only seems to be as happy as the latest tweet or Chinese news story will allow.
In other words, don’t bet on September trading remaining so smooth and relatively quiet—especially with the Fed meeting coming up next week and the European Central Bank (ECB) tomorrow. Maybe people are starting to realize it could still be a turbulent month because it doesn’t look like VIX is primed to test July lows near 12, at least not the way it’s traded this week. The 15 level has represented pretty good support.
Switching for a moment to earnings, it’s a relatively light time of month but Oracle (ORCL) breaks up the quiet when it reports tomorrow afternoon. We’ll talk about its prospects in tomorrow morning’s Market Update.
FIGURE 1: EURO OFF LOWS BUT WEAK AS ECB MEETS: Going into the European Central Bank (ECB) meeting that wraps up tomorrow, the euro has been falling against the dollar (candlestick) and recently skidded to two-year lows below $1.10. At the same time, the U.S. 10-year Treasury yield (TNX-purple line) made a major recovery over the last few days to trade at its highest level in more than a month. Data Sources: CME Group, Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
ECB Awaited: Focus is likely to zero in on the ECB outcome early tomorrow. The ECB is widely expected to cut its deposit rate for the first time since 2016 and restart an asset purchase program, Reuters reported. Interestingly, European banks have been the sector rallying into the meeting, maybe amid hopes that stimulus from the ECB could spark business loan demand. Typically, lower rates hurt financial stocks, and banks are the worst-performing sector in Europe so far this year as rates remain negative. The euro has weakened vs. the dollar.
There doesn’t seem to be much conviction in European markets that another round of central bank stimulus can recharge the slowing economy over there. Interest rate curves point toward negative ECB rates until 2030, and the new wave of monetary policy easing “represents a significant input cost shock for Europe’s banks, which face the real prospect of declining revenues,” UBS analysts wrote, according to Bloomberg.
Cat Out of Bag: There’s an old saying in the markets that once the media notices a trend, it’s over. That might be the case this week with small-cap stocks, as the Russell 2000 Index (RUT) once again outperformed broader indices on Tuesday after spending months trailing its bigger cousins. A spate of recent reports (including here in this column) pointed out how small caps weren’t keeping up, and now, whether coincidentally or not, they’re on the rise. As some analysts said, small-caps tend to reflect the health of the domestic economy more than large-caps, so if this rally starts to extend, that could be a positive sign for U.S. growth. It’s also another potential sign of the repositioning we’re seeing around the market this week.
Man Vs. Market: In the battle of one man vs. financial markets, the markets usually come out on top. However, that theory got tested Tuesday when National Security Advisor John Bolton left the Trump administration and crude oil prices took a dip as the headlines flashed. Bolton has a reputation as a major hawk on Iran, so the thinking might be that his departure could open the way back to an easing of relations between Iran and the U.S. If that happens, it could mean less geopolitical tension around crude prices, but it’s a long process and there’s no sign now of the U.S. inching back toward the nuclear agreement.
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