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What Next? A Dash of GDP and Geopolitics as Eventful Q3 Nears End

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September 25, 2017

(Monday Pre-Market) Escalating geopolitical tensions, possible profit taking at the end of the quarter, and a few key economic numbers could be in focus on Wall Street over the coming days. Investors also continue to digest the long-term implications of the Fed’s policy meeting last week and monitor Washington, D.C., for possible action on healthcare and taxes.

In all, a busy week lies ahead, and it’s unclear what issues or events might take precedent. Unlike last week, when the Fed meeting was a clear fulcrum, this week brings a swirl of issues, any of which have the potential to swing markets higher or lower. Defensive trading appeared to be in vogue late last week amid more geopolitical rumblings between the U.S. and North Korea, but we’ve also seen the market behave very resiliently over past weeks and recover from these fears pretty quickly. It’s also unclear how long the war of words between the two countries’ leaders might dominate the news.

Though the international scene has the potential to move markets pretty quickly, the ticking quarterly clock could play a big role as well in coming days as the last sessions of the quarter come into view. There’s a school of thought that market gains so far this quarter might lead to potential profit taking as the Q3 winds down. That might be part of what ate into the info tech sector late last week, with hard-charging names losing ground from recent highs.

The question is whether a longer-term move out of info tech might be underway, and, if so, where investors might shift that money. Don’t count info tech out, however, because it’s had a few bumps in the road so far this year and always has recovered. It remains by far the leading sector of 2017, and with earnings ahead next month, new catalysts could be on the horizon.    

Anyone looking for catalysts sooner than earnings can check out the data schedule, with August Personal Consumption Expenditure (PCE) prices due this coming Friday. Economists often say this is the Fed’s “preferred” inflation monitor, and it’s been notably weak over the last few months. The interesting thing could be to see how PCE prices compare with the August consumer price index (CPI), which showed inflation a little above expectations year-over-year and near the Fed’s 2% target. Fed Chair Janet Yellen admitted last week that the low level of inflation is “mysterious,” and it’s probably going to be a topic of conversation for some time to come.

Also on the data front: New home sales for August and preliminary consumer confidence for September both hit the wires early Tuesday, and August durable orders are due Wedneday. Thursday brings the government’s final estimate for Q2 gross domestic product (GDP), which stood at a solid 3% last time out but which many analysts expect could fall in the final round (see below).

Don’t count Washington, D.C., out as a possible market driver, either. Eyes could be on the Republicans’ effort to push through an Obamacare repeal, along with any signs of progress on tax reform.

There’s still some buzz after the Fed’s long-awaited announcement last week of plans to start drawing down its $4.5 trillion balance sheet by allowing a small amount of its mortgage and debt holdings to fall in months to come. Debate continues on the airwaves about the ultimate ramifications, but early market reaction has been pretty muted. The main effect so far seems to be a slight rise in Treasury yields, with 10-year yields trading around 2.26% as of midday Friday. Gold has also come down a good deal, though it rose Friday amid the geopolitical uncertainty.

From a high level view, the Fed’s initial monthly drawdown amounts are pretty low, though they’ll presumably grow over time. Also, as some economists have observed, the U.S. Treasury market still could look attractive to investors compared with foreign government bonds at this point even with the Fed’s move leading to more supply on the market. The relatively wide gap between U.S. yields and yields of foreign bonds like the German bund — which trades near 0.45% — could potentially mean a smaller chance of rising Treasury bond yields choking off U.S. economic growth.

S&P 500

FIGURE 1: AS THE QUARTER TURNS.

Both the S&P 500 (SPX) and the Dow Jones Industrial Average ($DJI, represented by the purple line), have pulled back slightly here since the Fed meeting, but remain on pace for solid quarterly gains as the end of Q3 draws near. Data source: Standard & Poor's, Dow Jones. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Dialing Down GDP Forecast: The government’s final read on Q2 gross domestic product is due this coming Thursday, and expectations appear to be for a lower number than last time. In its most recent estimate, the government pegged Q2 GDP at a solid 3%, a big gain from the tepid growth near 1% seen in Q1. But the Atlanta Fed’s GDP Now indicator currently sits at 2.2% for Q2. A number of factors work into the calculation, but it appears that weak real residential investment and a fall in the contribution of net exports might have brought the indicator down to its current level. What’s really dramatic is how far the GDP Now indicator has fallen from its level of 4% in early August. However, the Atlanta Fed indicator is below Wall Street’s consensus, which sits between 2.5% and 3%.

End-of-Quarter Watch: As the end of the quarter approaches this coming Friday, investors might want to consider being prudent for any last-minute maneuvering by major investment firms that often happens around this time. Position squaring could be on the immediate horizon as those firms might look to exit the quarter with profits in place after what’s been a positive quarter for the major indices. Uneasiness surrounding North Korea-U.S relations could play into some investors’ urges to take money off the table, as well, Briefing.com noted. This type of trading sometimes accelerates volatility in the final days of the quarter, so that’s another thing to potentially look out for. On the other hand, volatility seems pretty muted going into the week, with VIX falling below 10 early Friday.

Brexit Returns To Front Burner: The long-running Brexit saga returned to the headlines Friday when UK Prime Minister Theresa May addressed the topic in a speech in Florence, Italy, adopting what appeared to be a conciliatory tone. May accepted that the current status quo trading relationship between the UK and European Union should remain during the transition period to Brexit, and that the UK will pay its share to make sure no other countries have to pay extra during the current budget round, according to media reports. May sounded a little vague about what sort of future trading relationship she wants with the EU. Speaking of the EU, some positive economic data came out Friday on preliminary manufacturing and services PMI for the eurozone in September. Strong readings like these could accelerate expectations for the European Central Bank (ECB) to take its foot off the stimulus accelerator in months to come.

Good Trading,
JJ
@TDAJJKinahan

Economic Calendar

FIGURE 2: THIS WEEK'S ECONOMIC CALENDAR

Source: Briefing.com

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