Markets jumped last Friday despite a bit of Fed tapering talk, but a wave of incoming jobs data this week may alter opinions on the Fed’s schedule. Hurricane Ida weakens to tropical storm status, easing crude oil production concerns overnight.
(Monday Market Open) What is it about Fridays lately? Last week, Friday brought a critical speech from Fed Chairman Jerome Powell. This week, the August payrolls report comes Friday and could help shape market action and Fed policy as the month of September starts.
Generally, analysts think another solid jobs report might be the last straw on the camel’s back to get the Fed to start tapering its $120 billion a month bond-buying program. That program was designed to ease borrowing costs and underpin the economy during the pandemic. The last three months saw average job gains of more than 800,000, so judging from those numbers, it looks like the Fed has been moving toward its goal to bring down unemployment. Still, Powell made clear we haven’t come far enough.
We’ll talk more later this week about analysts’ expectations for the August jobs report and how it might be affected by both the Delta variant and wage demands. At an early glance, analysts expect another solid gain of around 750,000 new jobs, according to research firm Briefing.com.
One thing to keep in mind: the employment numbers come on the Friday ahead of the Labor Day holiday. Because many traders tend to square up positions and tiptoe out early to enjoy a long weekend, the numbers might need to be either a big hit or a big miss in order to have a major market impact. But it might also mean we see some extra gyrations between now and Friday.
But first, we have a few days of market activity ahead. Topping this morning’s newsmakers: Hurricane Ida made landfall in Louisiana last night, exactly 16 years after Katrina rocked the area. While most crude oil production in the Gulf of Mexico—and much of the power grid in and around New Orleans—is currently offline, Ida has been downgraded to a tropical storm, and initial reports seem to indicate the worst has been spared, particularly those oil rigs.
After last week’s surge in crude oil futures (/CL), Monday started to stabilize, possibly interrupting a rally that had barely clawed above a three-week high, as Hurricane Ida’s tropical downgrade may have eased the energy markets a bit.
Also easing crude concerns, OPEC+ meets Wednesday to discuss a scheduled 400,000 barrels per day output increase; OPEC delegates are likely to give the production ramp-up the green light.
For the moment, that “buy the dip” mentality which so many of us have gotten familiar with over the last few weeks appears to remain front and center. Friday was another example after Thursday’s moderate losses. All but two S&P 500 sectors rose on Friday, with Health Care and Utilities missing out, and “reopening” sectors like Energy and Financials again among the leaders. Those two topped the sector scoreboard last week.
For those keeping score at home, Friday marked the 52nd new high for the S&P 500 Index (SPX) this year, and the 31st new high for the Nasdaq (COMP:GIDS).
Small-caps also rebounded Friday, a positive sign for anyone worried that a lagging Russell 2000 Index (RUT) might be a harbinger of some kind of broader selloff, as it sometimes has been historically. Recent dollar strength— which tends to help small-caps gain ground over large-caps—may be one reason for RUT’s revival.
Having said that, some of the best performing stocks on Friday aren’t known for being too small. They included Occidental Petroleum (OXY), Freeport McMoRan (FCX), Caesars Entertainment (CZR), and Advanced Micro Devices (AMD). Looking at these names, you see a nice sweep across many sectors including oil and gas exploration, mining, hotels and casinos, and semiconductors. It’s just one day, but if the market is healthy, that kind of diversification among the strongest performing stocks is what you often see.
Beyond that, Friday was a good day for the Tech “mega-caps,” too, like Facebook (FB) and Alphabet (GOOGL). Some analysts had worried that the five or six heavily-weighted mega-caps were too dominant in the recent rally and may have made things look better than they actually are. That wasn’t the case on Friday, at least.
We’re getting into a bit of an earnings desert here in these steamy days of late August, but maybe—as your grandma might have told you—investors can cool off with a bowl of hot soup as Campbell Soup (CPB) reports this week. Zoom Video (ZM). Chewy (CHWY) and Broadcom (AVGO) are other earnings to consider watching over the next few days before things wind down for the Labor Day holiday next Monday.
Even before Fed Chairman Jerome Powell’s speech on Friday, the market had been making new highs. His words didn’t appear to change the course as major indices plowed higher again into the weekend, and index futures start Monday morning with a slight extension of the rally.
More importantly, maybe, is what we saw with volatility after Powell’s remarks. The Cboe Volatility Index (VIX) had been flirting with 20 earlier last week, but by the end of the day Friday it was back below 17 and near recent post-Covid lows. It’s hard to find a better sign that the market approved of Powell’s comments.
Yes, Powell did make it clear the Fed has plans to eventually, maybe soon, begin to cut back on its bond purchase program. However, he didn’t say exactly when, and he also made it very clear that the Fed sees the tapering of bond purchases as a different process from any eventual rate hikes. That may have soothed investors who might have worried the Fed could go back quickly to the kind of regime we saw back in 2018 with regular interest rate increases.
The market also appeared soothed by Powell sticking to his favorite word, “transitory,” to describe inflation. He also defined it a bit more clearly. A lot of the price increases have been in durable goods, as demand for those items soared during the pandemic, while demand for services lagged. Some of the price pressure on durables, like used cars, he said, is already starting to go away and may actually fall. This could ease inflation in the months ahead, perhaps putting less pressure on the Fed to change policy too much.
He also made it clear that he hasn’t seen the price pressure start affecting wages. While we’d all like people to get paid more, the concern the Fed has is possible higher prices leading employees to demand higher wages, forcing companies to raise prices to pay their workers, a kind of “wage-price” spiral, so to speak. Powell said he’s seen no sign of that, but the Fed continues to closely watch inflation expectations and would clamp down quickly if those started getting out of hand.
The Fed meets Sept. 21-22, and anticipation could rise ahead of that meeting as investors debate whether the taper calendar might be revealed then. A lot could depend on jobs and other data before that. If the Fed sees more progress on employment in early September, some analysts think we might see a September taper timing announcement as more likely. The Delta variant, however, could have a say in that, too. Case counts—as well as fresh lockdowns and mask mandates—have been rising across the globe.
If the Fed announced tapering plans in September, maybe we’d see its bond purchases slow down late this year or early next. Some Fed presidents around the country are calling pretty loudly for a tapering relatively soon to ease pricing pressure. It sounds like Powell is just about on their page, so to speak.
Looking further ahead, the market sees chances of a rate hike as slim to none before next June, when the CME Fed funds futures contract indicates about a 12% chance of a first rise in rates. Even a year from now, there’s more than an 80% chance that rates will be right where they are now, the futures market tells us. The first month when the market sees a more than 50% chance of higher rates is December 2022.
That’s a bit earlier than the Fed’s last projections released in June, where most Fed officials didn’t expect the first hike until 2023. We’ll get a new set of Fed projections next month and it could be interesting to see how that squares with market expectations.
It might be tempting to use a possible taper announcement—along with the fact that September tends to be a relatively weak month historically—as a reason to lighten the load. But remember: August also tends to be weak historically, but barring any sort of late-month pullback, we could see a 2% gain on the month in the SPX.
CHART OF THE DAY: RUT REBUT. Earlier this month there were worries that small-cap stocks (RUT—candlestick) might drag down the broader market, as we’ve seen sometimes in recent years. However, the RUT rebounded over the last week or so and is back to levels last seen more than a month ago, as this three-month chart shows. It still lags the S&P 500 Index (SPX—purple line) during that time period. Data Sources: FTSE Russell, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.
Covid Trends that Last: Earnings late last week from Salesforce (CRM) could serve as a good reminder of something we’ve talked about a lot during the pandemic. Namely, the “stickiness” of a product. Even before the earnings data, CRM was having a nice year in the market after its acquisition of Slack. Shares of CRM initially took off when Covid hit as people got stuck at home and cloud demand got traction.
As we’ve often seen, once people start using a product, they don’t necessarily stop just because circumstances change. Even though many workplaces are now open again, CRM raised guidance and continues to see acceleration in its business. Also, its executives said Thursday they don’t see a negative impact from the Delta variant.
Two Camps at the Fed? The speech Friday by Powell sounded pretty “dovish,” because he basically kicked the can down the road on when the Fed might announce tapering its asset purchases. Analysts are now divided about whether the Fed could make that announcement at its September or November meeting. It also illustrated what could be a developing divide at the Fed, because several Fed presidents who spoke before Powell last week urged a quick transition to tightening policy based on signs of rising inflation. Powell sees the inflation, too, but continues to say it’s “transitory” and more focused on the durable goods part of the economy. He worries if the Fed moves too soon to dampen inflation, it could damage the recovery.
However, the Fed presidents could arguably be closer to their respective business communities, and are hearing straight from those contacts about supply shortages and price hikes. Many small firms continue to deal with those issues, and for them it may be hard to agree with Powell that inflation is “transitory.” They ultimately could face the tough choice of whether to raise prices for their customers or take a hit to their margins, and perhaps they think the Fed should move more quickly to tame the inflation beast. Powell, on the other hand, said in the past when the Fed moved too quickly on inflation, it hurt jobs growth.
Sectors to Watch if a Taper Starts: Despite Powell’s dovish tone, his speech did make it pretty clear we’re getting close to a tapering of the Fed’s $120 billion a month bond-buying program. The question that he didn’t answer is when will this start? Last week, analysts at Goldman Sachs (GS) raised the odds of the Fed announcing a taper at its November meeting to 45% from its prior 25%. If it starts looking like we’re approaching this move by the Fed, remember to keep an eye on several sectors for possible reaction. Often, it’s growth sectors like Tech and Communication Services that feel the blow of possible higher rates more than other sectors. That’s what we saw when the Fed kept tightening rates back in late 2018 and the Tech sector led a dramatic Q4 market dive. Tech also got slammed earlier this year when 10-year Treasury yields made a meteoric rise.
Financials are one likely sector that could benefit if the Fed starts tightening, but so far bond yields just haven’t been moving the way you might expect considering there’s so much talk of a more hawkish Fed policy. Higher yields typically help profit margins at the big banks. However, the 10-year yield actually fell about two basis points in the hour after Powell spoke on Friday. That could indicate that the bond market continues to agree with Powell about inflation being transitory. It could also have to do with Powell clearly separating bond-buying policy from rate policy in his speech.
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