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Market Update

Wall Street Goes to Washington: House Tax Vote, Budget Battle Looming

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December 20, 2017

(Wednesday Market Open) Washington remains front and center as the week advances, with a final House vote on tax legislation expected today and drama mounting about whether Congress can keep the government running. Stocks moved higher in pre-market trading following mixed results in Europe and Asia.

Sometimes when long-awaited news finally breaks, the market cools off. That appears to be what happened Tuesday as stock indices fell despite Congress voting on tax reform legislation designed to reduce corporate tax rates to 21% next year from 35% currently. The Senate voted in favor last night, the House is expected to vote again today after a procedural hiccup yesterday, and President Trump is expected to sign the bill before Christmas. As the old saying goes, it looks like some “buy the rumor, sell the fact” action took place Tuesday, but we’ll see if that’s out of the market’s system today.

Profit taking might be coming into play here, too, especially with the year drawing toward a close and stocks up big so far in 2017. With the Nasdaq (COMP) up 29% for the year and the S&P 500 (SPX) up nearly 20%, there could be a natural inclination among some investors to take profits, especially in surging sectors like info tech. Still, market analysts seem optimistic about the market’s fortunes heading into next year. Many say cyclical sectors like financials and industrials have a chance to continue plowing higher. If the president moves next on infrastructure, as he recently said he plans to, that could reinforce hopes for strength in sectors that would potentially supply the muscle and materials to get that done.

The question going forward, now that tax reform seems pretty much a given, is when and whether these tax cuts help deliver bigger wages. Hourly pay growth has been tepid most of the year, and that could be one thing that’s helping keep inflation at current low levels. The Fed indicated last week that three rate hikes might be in store for 2018, but if wages start edging up and inflation awakens, it could be interesting to see where the futures market and Treasury yields start pointing.

Speaking of Treasuries, with passage of the tax bill, Treasury yields rose to their highest levels in nearly two months. That followed yield gains in Europe earlier Tuesday as optimism grew that the tax cuts might stimulate economic demand not only in the U.S. but possibly overseas as well. The U.S. 10-year yield, while still low from a historic perspective (see below), pushed through technical resistance at 2.45%.

The positive economic sentiment also appeared to weigh on some of the market’s more “defensive” categories Tuesday, with utilities taking a big dive of nearly 2% and telecom also heading lower. Gold also fell slightly, but remains above recent longer-term lows posted last week in the $1,240 an ounce range.

Real estate stocks took it on the chin Tuesday. The Wall Street Journal reported that the tax legislation could wipe out some of the perks that encourage home ownership and possibly cause real estate prices to fall in parts of the country. There was a report out this morning that mortgage applications fell last week.

We’re not done yet with corporate news for the year. Shares of Apple (AAPL) fell about 1% Tuesday after an analyst downgraded the stock, but AAPL remains near recent record highs. In addition, Darden Restaurants (DRI) jumped sharply as the company reported a strong fiscal Q2 and raised guidance. Wal-Mart (WMT) also performed well after getting an analyst upgrade.

Also, FedEx (FDX) and Micron (MU) both reported earnings that beat Wall Street analysts’ expectations. FDX is definitely one to watch, considering the company is responsible for delivering so many packages ordered in the online world this holiday season. The company increased its forecast for fiscal 2018, citing “enhanced revenue quality” and “solid demand trends,” FDX said in a press release

We’re not done with Washington news, either, for that matter. Congress has to find a way by Friday to keep the government open, or a shutdown could happen this weekend. It’s unclear how much impact that might have on the market, especially with stock trading closed this coming Monday for Christmas. It’s possible that volatility could perk up in coming days as the congressional deadline approaches. However, the VIX remains well below 10.

10-Year yields.

FIGURE 1: YIELD LEAP.

Ten-year Treasury yields (candlestick chart) jumped to nearly two-month highs Tuesday as Congress voted on a tax reform plan that many analysts expect to help boost corporate profits. The dollar (purple line), didn’t seem to respond, however, and remains well below recent highs. From this three-month view, it appears the 10-year yield has carved out some technical support right around the 2.3% mark, a level it’s bounced off of three times in recent weeks. Data source: CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.    

Running in Place: The 2017 finish line is just around the curve, and U.S. 10-year Treasury bond yields are basically all the way back to where they started. Yields ended 2016 at 2.44%, and traded just a basis point above that level on Tuesday with less than two weeks left in the year. It’s not like yields haven’t gone anywhere in between. They climbed above 2.6% last March and fell to nearly 2% in September, but they’ve spent much of the year between 2.2% and 2.4%.

These are historically low rates. To put things in perspective, consider the relationship of 10-year yields to the federal funds rate, which the Fed raised last week to between 1.25% and 1.5%. The previous time the Fed raised rates to this range — in June 2004 — the 10-year yield stood near 4.6%, or nearly double its current levels. The difference this time could be extremely low overseas yields, especially in Japan and Europe. The Fed may be pulling stimulus away, but stimulus continues in those foreign lands, keeping rates much lower there and perhaps spilling some of the European and Japanese caffeine into U.S. markets. This wind blowing from across both oceans is arguably one factor keeping domestic borrowing costs down, perhaps allowing the Fed to raise rates with less fear of slowing the economy.

Get Ready for GDP: The big news coming up Thursday morning at the opening bell is the government’s final estimate for Q3 gross domestic product (GDP) growth. The estimate last time out was 3.3%, and that’s where Wall Street analysts expect tomorrow’s number to stay. The 3.3% growth rate — if it holds — would be the best for any quarter since Q1 of 2015. A bigger question now is how Q4 growth might be shaping up, considering less than two weeks remain. If the economy can again grow 3% or better, it would be the first time in many years that it posted three consecutive quarters of 3% growth. The first government estimate for Q4 GDP is due Jan. 26.

Homes for the Holidays: The rebound in housing appeared to continue in November, as Tuesday’s data showed strong housing starts and building permits for the month. Today brings November existing home sales. The report, due this morning, could help shed more light on home prices, which have been among the factors keeping existing home sales from really taking off this year. Sales were down 0.9% year-over-year in October. Wall Street analysts expect existing home sales of 5.55 million in November on a seasonally adjusted basis, up from 5.48 million in October, Briefing.com said. Median prices have been rising 5% or more year-over-year for many months, so keep an eye on that metric for any signs of a possible slowdown that might signal more supply.

Good Trading,
JJ
@TDAJJKinahan

Economic Calendar

FIGURE 2: THIS WEEK'S ECONOMIC CALENDAR.

Source: Briefing.com

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