Bright Start: Market Gains Some Traction With Powell, China Talks Ahead

The market is off to a pretty strong start this week as investors await a speech Wednesday from Fed Chair Jerome Powell and weekend trade talks between China and the U.S.

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Key Takeaways

  • Powell speech Wednesday looms large as investors look toward 2019 policy

  • Stocks forge back from early weakness Tuesday to post modest gains

  • FAANGs remain weak, but retail stocks do well after strong shopping weekend

(Wednesday Market Open) Fed Chair Jerome Powell takes center stage Wednesday when he steps to the podium at the Economic Club of New York. With other Fed speakers recently sounding a bit more dovish, the question is whether Powell might say anything that reinforces hopes for a less active central bank in 2019. 

Going into Powell’s noon ET speech, the market seems to have a more positive tone after consecutive strong finishes Monday and Tuesday. While there’s still a lot of emotion hanging over the Street ahead of Powell, optimism might be growing a little going into weekend trade talks between the U.S. and China. When it comes to market sentiment, tariffs still rule the roost. Just about every big move recently has been related to China, one way or the other, so watch for potential volatility ahead of that big weekend meeting.

From a data standpoint early Wednesday, the government left its estimate for Q3 gross domestic product (GDP) unchanged at 3.5%. New home sales for October also bow this morning. Tomorrow afternoon brings Fed minutes from its November meeting.

There was also some earnings news late yesterday and early today. Tiffany’s (TIF) shares got crushed Wednesday in pre-market trading after the company’s same-store sales rose but missed Wall Street analysts’ estimates. This probably reflects a drop in tourism and a strong dollar more than anything, so it’s not necessarily time to panic about the high-end consumer. 

On a more positive note, shares of business software firm Salesforce (CRM) heated up with an 8% jump in pre-market trading after the company not only easily beat analysts’ estimates on earnings, but, perhaps more importantly, delivered a strong outlook.

Powell Speech Takes Center Stage

Though his speech has an academic-sounding title, “The Federal Reserve’s Framework for Monitoring Financial Stability,” many investors are waiting to hear if Powell addresses the subject on so many minds: The Fed’s interest rate thoughts heading into 2019.

While there’s no guarantee of Powell saying anything meaningful about rate policy, it’s probably a good idea to monitor his speech and see if he echoes any of the more dovish comments made by Fed Vice Chair Richard Clarida, who on Tuesday said the Fed funds rate is “much closer” to neutral than it was three years ago when rates began going up from essentially zero. No one at the Fed has pinpointed what exact number “neutral” might be, but Clarida said it’s important that the Fed be “data dependent” about future moves.

Powell last talked about “neutral” roughly two months ago when he said current rates (which are the same now as they were then) were “a long way” from neutral. Some analysts think that was one factor that helped lead to the sell-off in October.

At this point, the futures market puts nearly 80% odds on a fourth 2018 rate hike next month, but odds of another hike next year have come down a lot in recent weeks. While the Fed’s “dot-plot” on Dec. 19 will probably be the best way to get insight into what might happen in 2019, there’s a chance Powell could provide some kind of preview. Just remember, though, that it’s possible that the speech might not touch on any policy thoughts.

Also, consider listening for any observations he makes about inflation. Remember, Powell hasn’t really addressed this topic much since crude oil prices cratered over the last month. A weaker crude environment could mean less price pressure, perhaps meaning less pressure on the Fed to raise rates.

Perking Up

Clarida’s dovish remarks Tuesday might have helped change the market’s tone a bit after early weakness related to tariff worries and the announcement that United Technologies (UTX) would be broken up into three separate companies. UTX, which is a Dow Jones Industrial Average ($DJI) component, fell 6% on the news and didn’t come back much as the day advanced.

Another $DJI stock that took an early beating Tuesday was Apple (AAPL), which fell after President Trump threatened tariffs on the iPhone. However, unlike UTX, AAPL shares did claw back to recover most of their losses during the session. That doesn’t negate the fact that AAPL is down about 25% from its all-time highs (see more below), and has lost hundreds of billions in market-cap since an earnings report that disappointed many investors.

Though tariff worries seemed to take a bite out of AAPL Tuesday, the rest of the market got a lift from what sounded like bullish comments on China from Larry Kudlow, a White House economic advisor. As the administration prepares for Saturday’s dinner date featuring President Trump and Chinese President Xi, Kudlow told the media, there’ve been talks “at all levels” between the two governments. 

There was also some decent-looking data Tuesday, with consumer confidence for November falling just slightly to 135.7. That was a little above the average analyst estimate, and down just a tad from the 18-year high it reached in October. If the market’s correction since early last month is having an impact on consumers, it’s hard to tell from Tuesday’s numbers.

Another reflection of consumer confidence was Cyber Monday sales, which hit $7.9 billion, the largest ever, according to Adobe. That was up 19% from a year ago. Also, 165 million Americans shopped over the long weekend, Adobe said, about 1 million more than analysts had expected. Consumers do appear to be holding up their end.

Most of the FAANGs didn’t seem to get much of a lift from the consumer news, with only Netflix (NFLX) making decent gains Tuesday. Some of that FAANG weakness probably helps explain why Nasdaq (COMP) barely moved even while the S&P 500 (SPX) and $DJI posted moderate gains. However, some of the retail stocks, including Macy’s (M) and Target (TGT), posted strong finishes. For the most part, retailers appear to be doing well.

Basically, it looks like a waiting game as Wednesday begins. Action might be slow ahead of the Powell speech, and unless Powell says something the market interprets as meaningful,  it might be hard to get much more direction until the weekend meeting between Trump and Xi. 

Figure 1: Mind Your 10s and 2s. The spread between the 10-year Treasury yield and the 2-year Treasury yield spent 6 months of the year—from Feb-Aug—on a narrowing path, from over 75 basis points down into the teens. It widened out to about 35 basis points, but a Fall 2018 equity meltdown, combined with a Fed that has continued its path of incremental hikes to the Fed funds rate, has seen the spread between 10s and 2s narrow again in recent weeks. Source: Federal Reserve's FRED database. FRED® is a registered trademark of the Federal Reserve Bank of St. Louis. The Federal Reserve Bank of St. Louis does not sponsor or endorse and is not affiliated with TD Ameritrade. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Payback Time: Corporate debt might not sound like the most exciting subject, but the recent rise in interest rates is putting it back into focus. Many large companies took advantage of record-low borrowing costs earlier in the 2010’s to take on debt for acquisitions, capital improvements, stock buybacks and other spending programs. In the last decade, the amount of corporate bonds outstanding nearly doubled to $9 trillion, from $5.5 trillion, The New York Times said Tuesday. A lot of that debt has relatively low ratings, meaning there’s higher odds of default. Now there’s concern that as interest rates rise and the economy appears to be slowing in some sectors, some major companies might have trouble paying back what they borrowed. This includes a few big blue-chips, and also the energy sector, where a lot of the shale-drilling companies are highly leveraged. As The New York Times pointed out, when big companies start having trouble with debt, it can sometimes become harder for ordinary Americans to borrow in the future. 

Race for Market Cap: Back in August and September, when the stock market was flying high on its way to record heights for all the major indices, two companies—Apple (AAPL) and Amazon (AMZN)—made headlines of their own by reaching the lofty $1 trillion market cap. While it’s always possible we could see a sharp shift in fortunes, at this point those headlines seem a little quaint considering the worse than 20% dives each stock has taken since. In fact, one school of thought suggests that AMZN and AAPL reaching $1 trillion might have represented a signal that the market as a whole had become overbought and helped trigger the breakdown in October and November. At this point, another tech name, Microsoft (MSFT), has nearly caught up with in valuation with AAPL, and AMZN is well behind both. As of midday Tuesday, MSFT’s market cap of $822.62 billion was just inches behind AAPL’s $823.18 billion. AMZN was way back with $771.71 billion. This reflects in some sense the fact that MSFT has performed far better than the other two since the market peak in early October, with shares down less than 8% since then.

Nifty 50 Repeat? Not So Fast: It’s only been two months since AAPL, AMZN, Facebook (FB) and other FAANG stocks fell off a cliff on their way into bear market territory, but already some analysts are wondering if the momentum that carried them and helped the rest of the market might be behind us. Some are even comparing them to the so-called “Nifty 50” stocks that dominated the market rally in the 1960s and 1970s before losing steam. It’s a bit early to draw those kind of conclusions, however. Just two months ago many of these names were still among the market’s strongest, and all of them remain viable companies, some with billions of social media users or phone buyers. That’s why comparisons to the 2000-2002 Internet crash don’t seem fair, considering that many of the high-flying tech companies then didn’t really have any earnings or sales to speak of. 

Good Trading, 

JJ

@TDAJJKinahan 

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