Futures Swing from Negative to Positive on Merck Report, Can Stocks Hold Under the Dark Cloud of the Debt Ceiling

A new month and a new quarter appear to be starting off on a positive note as futures are trading higher before the open. September ended on a down note as the S&P 500 closed below its 100-day moving average. The debt ceiling remains a dark cloud over the markets and could influence key levels on the dollar and other commodities. China’s problems add up with lower manufacturing numbers.

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5 min read
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Key Takeaways

  • Looking at the New Month and the New Quarter 

  • More Bad News for China After a Lower Than Expected Manufacturing Report

  • Asian Central Banks Buying Treasuries and Complicating Portfolio Diversification

(Friday Market Open) The new quarter appears to be starting off on a slightly higher note as futures are pointing to a positive opening. Stocks are being helped by the drug company Merck (MRK) and Ridgeback Biotherapeutics which are partnering on an experimental COVID-19 pill that has new data showing success in helping to prevent high-risk people avoid serious illness and death. Merck was up nearly 8.5% in pre-market trading. The news appeared to bring the futures markets from a negative open to a positive open.

In a sign that life may be returning to normal, JP Morgan analysts showed Southwest Airlines (LUV) the love by upgrading them to overweight. This seems to signal that these analysts see light at the end of the delta variant tunnel. Additionally, Disney (DIS) announced its settlement with actress Scarlett Johansson over her Black Widow movie.   

The personal income report came in as expected while personal spending was slightly higher than projected. The Core PCE Price Index showed that inflation grew in line with expectations. The 10-year Treasury Note (TNX) had already traded lower before the announcement and was relatively unchanged afterwards. The ISM Manufacturing number comes out after the market open.

The question is can Friday’s higher pre-market push hold up? Thursday’s upbeat start ended in a down note as the Dow Jones Industrial Average closed 1.59% lower and about 5% off its all-time high. Higher than expected weekly jobless claims and disappointing earnings from Bed Bath & Beyond (BBBY) and CarMax (KMX), as well as, McCormick (MKC) lower guidance helped pulls stock to lower levels.

The S&P 500 (SPX) ended the previous quarter down 5.8% after breaking through important technical levels on the 50-day moving average in the middle of the month. Then breaking below the 100-day moving average yesterday. Many technical analysts may choose to target the 200-day moving average as the next short-term down move. The 200 is currently hovering around the 4134 level.

Outside of the seasonal September Slump, the other dark cloud over the markets is the ongoing debt ceiling issue. The debate has been held up by a spending bill that has caused a rift between moderate and liberal Democrats. To get around the matter, the Senate passed a continuing resolution that could fund the government through December 3. Briefing.com reported that the resolution is expected to pass the House. House Speaker Nancy Pelosi plans to put the resolution up for vote on Friday. The resolution allows Congress to table the spending bill for a couple of months and focus on the debt ceiling.

Breaking China

The China manufacturing purchasing managers index fell in September breaking an 18-month expansion. The report surprised analysts who had forecasted no change. The Wall Street Journal reported that China was quick to recover from the pandemic but continues to be hindered by regional COVID outbreaks, supply chain disruptions, port shutdowns, rising commodity prices, the semiconductor shortage, and rising economic regulations.

China’s manufacturing now faces a rising energy crisis that could further hurt its production. Morgan Stanley (MS) economists project a potential 1% loss in China’s fourth quarter gross domestic product if these issues continue. The lower target adds to a growing list of reduced projections from other analysts including Nomura, China International Capital, Goldman Sachs, S&P Global, and Citigroup.

October Scares

While China’s increasing list of issues can be a cause for concern, there’s still little indication that the recent downturn was nothing more than a regular September Slump. However, as we move into a new month and quarter, investors should be aware that October has a reputation of being downright scary at times. October has hosted The Bank Panic of 1907, The Crash or 1929 that kicked off the Great Depression, and 1987’s Black Monday. However, the Stock Trader’s Almanac reports October as a relatively positive month on the average.

After money managers spend September switching up their portfolio allocations in preparation for the end of the year, markets often find a bottom in October and then kickoff the fourth quarter. The almanac shows that the fourth quarter tends to be the strongest seasonal cycle for stocks.

It’s important to remember that the almanac deals in historical averages and not future price prognostications. There are, of course, ongoing risks like the debt ceiling, rising yields, energy shortages, and a weakening Chinese economy that could make this October a little spooky. Only time will tell. 
historical oil prices

CHART OF THE DAY: THE HISTORY OF OIL. Crude oil (/CL—candlesticks) is testing a resistance level around the $76 mark that stretches back to 2014. Before 2014, this same level acted as support. The previous resistance level was $110.  Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Have a Plan: Technical analysts use support and resistance levels as a way to identify where other investors may buy or sell a security. If crude oil breaks above its $76 level, many technicians would use the previous resistance levels to set their next price target.

However, while support and resistance lines may seem pretty concrete when looking at history, the market doesn’t look for the lines on your chart and change directions. Breakouts often fail, rallies weaken and don’t always reach the targets, and daily volatility can make the picture murky.

This is why many technicians have a defined plan that tells them when to place a trade, how much to trade, and when to exit. Exits usually include when to get out if things go bad, if thing go well, or if things go okay. In fact, many of them will use scaling methods to help control risk and take profits.

As Good as Gold: Speaking of support and resistance, the dollar, gold, and silver are trading at interesting levels. Precious metals havelost some of their shine as the U.S. dollar (DXY) has rallied over the last four months. Silver (/SI) is testing its $22 support level. Gold (/GC) is testing its August low. The dollar index is trading at 94.25, just 0.75 off its 2020 resistance level.

The confluence of support and resistance levels between these securities is not by chance. Before cryptocurrencies, precious metals were seen as one of the few alternatives to fiat currencies. If the dollar’s resistance level holds, then gold and silver support levels may also hold. If the dollar breaks resistance, then it’s likely that precious metals will breakdown.

As the debt ceiling debate rages on, faith in the dollar could wane and investors may choose precious metals as a hedge against the uncertainty. This could be an interesting area to watch over the next few days or even weeks depending on how long it takes Congress to figure out the debt ceiling.

Stocks & Bonds Decoupling: Another interesting relationship change is between the stocks and bonds. You can’t be in investing too long without learning about the importance of diversifying a portfolio between stocks and bonds. Generally speaking, when stocks rise, bonds will fall, when stocks fall, bonds will rise. These actions complement each other by offsetting some of the losses and gains in the other asset, although to varying degrees. Historically, both assets have grown over time and helped portfolios grow. Of course, asset allocation and diversification do not eliminate the risk of experiencing investment losses.

At times, the inverse relationship between stocks and bonds has decoupled where they generally move in the same direction. There are three extended periods where this has happened: 1997-1998, 2004-2006, and 2010-2011. In his book Intermarket Analysis, John Murphy found that this occurred in 1997-1998 because the Japanese central bank was buying up Treasuries to help support the deflating yen. A 2010 study by Citibank found similar results for 2004-2006 compared to what was being seen during 2010-2011 timeframe where Asian central banks were buying up Treasuries to support deflating currencies.

Since March of 2021, the S&P 500 (SPX) and the S&P U.S. Treasury Bond Index have moved in similar directions. Since both assets are moving higher, it’s been a positive for many investors. If both assets were to turn down this would obviously be concerning for investors. In the few times stocks and bonds have decoupled, this hasn’t been an issue. But, it’s certainly something to keep an eye on.

So, who is buying the Treasuries? The Financial Times reported on September 20 that China and Japan have been buyers once again. If the demand for Treasuries continue, investors may get the benefit of both assets rising. Additionally, the buying from Asian central banks could help make tapering easier for the Fed.

In case you haven’t noticed, relationships can be complicated. 

Good Trading, 

JJ

@TDAJJKinahan

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This week’s economic calendar. Source: Briefing.com
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Key Takeaways

  • Looking at the New Month and the New Quarter 

  • More Bad News for China After a Lower Than Expected Manufacturing Report

  • Asian Central Banks Buying Treasuries and Complicating Portfolio Diversification

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