(Thursday Market Open) One day after a record-setting Wall Street rally, another big bank posted robust results and China reported better than expected economic growth. Still, markets looked a little out of breath and ready to pause early Thursday as investors checked out the view from these lofty heights.
Morgan Stanley (MS), the last of the major financial firms to report this season, beat Wall Street analysts’ estimates with earnings per share of 84 cents and revenue of $9.5 billion. The wealth management division looked strong, but trading revenue declined. The company also took a one-time charge of nearly $1 billion related to changes in the U.S. tax code. In a press release, MS, said, “We enter 2018 with strong momentum aided by rising interest rates, tax reform and an evolving regulatory framework.”
That statement might apply to big banks almost across the board as the year gets underway. The fundamental picture for banks, which is tied closely to the factors MS mentioned in its release, looks pretty positive. The financial sector is up more than 5% so far in 2018, slightly ahead of the overall market.
Looking beyond earnings, China’s gross domestic product (GDP) climbed 6.9% in 2017, the government said Thursday, including 6.8% growth in Q4 that was better than Wall Street analysts had expected. Stocks in China rose after the economic data hit the newswires. European stocks presented more of a mixed picture, and Japan saw losses. Meanwhile, crude oil seems to be making itself comfortable right around $64 a barrel, hardly moving at all early Thursday.
Over in Treasuries, the 10-year U.S. yield climbed above last week’s high and reached 2.61% early Thursday. That’s not far from the 2017 peak of 2.63%, a level it hasn’t exceeded since 2014. Watch carefully today to see if yields can pierce that technical barrier, and whether stocks show any signs of fear that might come from the specter of possible higher borrowing costs.
Though the earnings calendar after today’s close isn’t extremely full, it does provide tidings from bellwether companies representing a nice variety of industries. Those reporting include American Express (AXP), IBM (IBM), and Canadian Pacific (CP), meaning financials, techs, and transports all come to the party. Transports have been riding high so far this year, and so have financials, while IBM shares came out of hibernation over the last month. One thing to watch is IBM’s revenue, which has fallen year-over-year for 22 consecutive quarters. Some analysts think that streak might finally get broken this time out thanks in part to strength in the company’s cloud and cognitive solutions categories.
So far this earnings season, management at many companies is pointing out potential tax reform benefits. Guidance for tax rates averages around 19%, vs. closer to 29% previously, according to research firm CFRA. That could be playing into the upward 2018 earnings revisions some companies have made.
Aside from earnings, a lot of attention is likely to focus on Washington, D.C., the next day or two as Congress tries to cobble together a plan to keep the government running after Friday. At this point, the sides seem pretty far apart, but history shows things have a way of coming together at the last minute. In the worst-case scenario that there is a shutdown, the market impact seems likely to be bearish. Stocks have typically fallen the first week after past shutdowns, though not by a huge amount. Past isn’t precedent, of course, but the markets tend to appreciate stability and fear the unknown.
Fear tends to push up volatility, and that wasn’t any different this week as investors eyed a possible shutdown. Volatility, as measured by VIX, remains elevated from recent lows. VIX was near 12 early Thursday, up from lows below 9 just a few weeks ago. It’s particularly odd to see VIX do this well with the market rallying so strongly. There’s an underlying current here that shows a relationship a bit out of line, and that might reflect more fear about the future than we see in the underlying market. The attitude appears to be “risk-off” for bonds but “risk-on” for VIX, and that may go beyond fear of a shutdown. We’re at all-time market highs, and people might want protection as they participate in the rally.
After swinging 384 points on Tuesday from big early gains to modest midday losses that had some market professionals using the word “reversal,” the Dow Jones Industrial Average ($DJI) pressed the “up” elevator button early Wednesday and never looked back, posting a better than 300-point advance and closing well above 26,000. The $DJI has already taken out two “thousand point” milestones since the start of the year.
Strength came from pretty much every sector Wednesday, but the leader board at the end of play showed info tech at the top, with gains of nearly 1.6%. Consumer staples gained 1.17% and health care rose almost 1%. This is an interesting mix, because unlike last week, when so-called “cyclical” sectors led and “defensive” ones lagged, Wednesday showed a good mix of both. That would seem to signal that investors are looking for opportunities across the market, not just in a few sectors that typically rise late in a long bull market like the one we’re in. Chip makers were among the tech leaders.
All 11 S&P 500 (SPX) sectors finished in the black Wednesday, and the $DJI was led by some of the same stocks that have propelled it since the year began, including Boeing (BA), IBM (IBM), United Health (UNH), and Cisco (CSCO). If you look at the industries those stocks represent, it reinforces the sense that this rally is pretty well rounded. Additionally, shares of Apple (AAPL), a $DJI stock that hadn’t been climbing as much as its 29 index peers over the last few weeks, shot up 1.7% after the company announced it would use tax reform as an opportunity to repatriate overseas cash holdings and invest in the U.S.
While pretty much no one probably expected the markets to rally this much so soon in the year, the positive sentiment isn’t too surprising considering all the bullish news. Data continue to look good, with industrial production for December growing 0.9%, the government said Wednesday. That was twice Wall Street analysts’ estimates and finished off the best year since 2010 for the category. Capacity utilization also rose. Reports like these can signal underlying strength in the economy, just as we saw earlier this month from a December jobs report that showed job growth in career-building fields.
China Syndrome: Remember a few weeks ago when we mentioned that loan rates in China recently reached multi-year highs? Now there are signs that the country’s gravity-defying housing market might be slowing. This week, The Wall Street Journal reported that real estate sales “have stalled” in Beijing and Shanghai, and prices have dropped, “dramatically,” in some cases. Higher mortgage rates could be partly to blame, the WSJ said.
If U.S. investors wonder why they should care about business loans and housing in China, think of these things as possible signals about the overall growth of China’s economy and possible future consumer demand there for U.S. products, particularly from tech and industrial companies that rely so much on big markets there. However, there’s no sign yet of any slowdown yet, based on today’s economic growth news.
How’s the U.S. Consumer Doing? OK, enough for now about Chinese consumers. What about consumers right here in the U.S.? A key data point to watch tomorrow could be University of Michigan Consumer Sentiment, which will cover the preliminary reading for January. The 2017 average of 96.8 was the highest for a full year since 2000, and sentiment for December was just a little below that at 95.9. The average Wall Street analyst estimate for Friday’s report is 97.0, according to Briefing.com.
One factor the report might measure is consumers’ initial reaction to tax reform passed late last month. Though extra cash isn’t expected to hit paychecks until February, according to Congress, the tax bill’s passage drew lots of media coverage in the period covered by the report. Another factor: Holiday shopping looked pretty robust, perhaps indicating confidence as people headed out to buy gifts. The National Retail Federation, (NRF), reported that sales in the November-December period increased 5.5% compared to last year, the highest since 2010.
Inflation Muted, But Dollar Struggling: The Dollar Index rebounded slightly on Wednesday but remains near recent long-term goals. While a weak dollar has some positive aspects for the market, notably because it tends to make U.S. goods cheaper on the international market, one concern about dollar weakness is possible domestic inflation. This is partly because a weak dollar tends to raise the cost of foreign goods for U.S. consumers, and also because oil is priced in dollars. When the dollar falls, oil often goes up, as we’re seeing now. Oil, as investors know, is arguably what makes the economy go around, and higher energy costs can hurt industries across the spectrum. At this point, inflation remains tame, but as long as the dollar is relatively weak, investors should consider watching for any signs of price creep. That said, the Dollar Index remains near 91, up from 76 back in 2014, so it’s not incredibly low.
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