(Monday Market Open) This was supposed to be a week focused on the Fed and a host of new data. Then tech stocks took a dive late Friday, upsetting the proverbial apple cart and raising questions about a sector that’s been the backbone of this year’s rally.
Info tech shares fell more than 2.7% Friday, mostly in the last couple of hours, and pressure continued in futures trading early Monday. Key stocks like Apple (AAPL), Amazon (AMZN) and Alphabet (GOOG) all came under fire as the Nasdaq (COMP) had its worst day in a while. Some of the selling appears related to analyst reports suggesting the sector might be overvalued. We have seen tech pull way ahead this year, leading all sectors with huge gains, but whether it’s overvalued is another question.
A couple things to consider: First, this isn’t the first tech pullback recently. Back in mid-May, the sector had an even worse day and bounced back. Another recovery isn’t out of the question, especially if some market participants see value at lower prices.
Second, the sector has rallied this year on fundamentals. Tech earnings came in strong in Q1. So it’s fair to say that recent strength is based on real growth, not on hopes and dreams the way it was during the “tech bubble” of 1998-99. Back then, Nasdaq often corrected a few percent before raging back to make new highs, and the temptation might be to think back to those days whenever tech stumbles.
However, the situations aren’t necessarily the same. For one thing, many major tech stocks aren’t trading at stratospheric multiples, the way they were back then. Also, business models tend to be better, and the companies leading the charge are much larger and more ingrained into the economy now than they were 17 or 18 years ago when Y2K was all the rage and Internet companies devoted to selling pet supplies or toys commanded billions in market cap.
If not for info tech’s breakdown, the week’s big event would be the Fed meeting Tuesday and Wednesday, but it’s fair to say there’s almost no drama around this one. A rate hike is essentially baked in, with Fed funds futures signaling 96% odds as of early Monday. Seldom have we approached a Fed meeting with such a sense of certainty.
Still, it’s never wise to dismiss the importance of a Fed meeting, especially when Fed Chair Janet Yellen is scheduled to hold a press conference afterward. One thing many people have indicated they want to get a better sense of is the Fed’s plan going forward, especially its efforts to balance future rate hikes with paring down its $4.5 trillion balance sheet. Fed funds futures point to about a 50% likelihood of one additional rate hike this year, probably coming in December. Some analysts think the Fed could get more granular about its balance sheet strategy as the year continues.
Looking beyond the Fed, economic data could play a key role in setting the tone, starting with the producer price index (PPI) on Tuesday, retail sales and the consumer price index (CPI) on Wednesday, industrial production Thursday, and housing starts Friday. Of all these, CPI might be most interesting, considering last time it came in pretty weak, with the core rate up just 0.1% in April.
Don’t forget Washington, either. The question is whether Congress can focus on key legislative tasks including tax reform, health reform, banking regulations, the debt ceiling, and infrastructure over the next weeks and months, or if it gets sidetracked by political turbulence, as we saw last week. A House vote on banking reform Thursday indicated some movement as far as legislative action, but Congress has a lot on its plate.
Other matters worth monitoring include a slowly rising U.S. dollar and slightly higher bond yields. Some of the defensive indicators like bonds and gold gave up a bit of their recent gains as the old week ended, perhaps signaling improved investor confidence. Overseas, the Bank of England and the Bank of Japan both have meetings in the coming week, so those could have possible impact on U.S. trading as well. In sum, there’s a lot going on.
Pax Britannica? Last week’s British election is over, but Great Britain is likely to remain in the news and could cause some volatility, especially in currency markets. Prime Minister Theresa May’s attempts to form a new government even as the country enters the next phase of the Brexit process later this month certainly could continue to weigh on the pound, which fell 2% vs. the dollar after the election resulted in a hung parliament. Some analysts think the pound has more room to slide, perhaps down to the 1.24 level from the 1.27 mark where it traded Friday. One sector to watch might be British banks, because if they struggle amid political uncertainty, it could benefit U.S. banks that compete with banks in London.
VIX Pops Back Up After Digging New Low: Volatility fell to new two-decade lows Friday, with the VIX dropping below its previous 2017 bottom to trade at around 9.50 by midday. But with tech’s late breakdown, VIX came back a bit, jumping to 11.67 by early Monday as uncertainty prevailed. Even at these levels, VIX remains historically low and well under its 2017 highs. Still, volatility could get a little more interesting to watch this week amid the tech weakness and the Fed meeting.
Watching the Financials: One question going into the new week is whether the financial sector can continue its climb after it had posted better than 3% weekly gains by midday Friday. The major indices have rallied to new records this year without much participation from the financial sector, so signs of life in financials might signal a new source of strength for the broader market. Typically, finance is considered one of the more important sectors, simply because it’s a strong proxy for the overall U.S. economy. Keep in mind, however, that next month brings Q2 bank earnings, and there have been some signs of fundamental weakness for some of the big banks, including lighter trading than expected. The current sector strength seems to stem mainly from economic factors, including rising bond yields and anticipation of a rate hike. Whether the industry’s own fundamentals remain healthy is something we’ll likely have a better sense of in July.
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