November 6, 2018

For most of last week, earnings from high-profile companies dominated the attention of the financial media and investors alike with a tremendous amount of debate as to whether the third quarter represented an earnings peak for the current economic cycle. This topic also dominated the first and second quarters as well, yet the economy continues to pleasantly surprise investors and frustrate the naysayers.

For many big-name stocks, selling on the earnings news has been the order of the day, especially if results failed to produce a huge upside surprise for revenues and sales. Before the market reversed itself last Wednesday, about the only sectors getting any love from investors were utilities, real estate, and a few consumer staples, as the appetite for safety and yield ruled sentiment. Roughly 90% of all stocks are now trading well off their late September highs, with some high-P/E growth stocks down as much as 40-50%.

The sell-off caused heavy technical damage and took a big toll on investor sentiment as forced selling by ETFs and computer-program selling implied a market devoid of stability. What was a smooth ride for most of 2018 is no longer the case. How the market reacts to the midterm election results, the upcoming G20 meeting and, most importantly, the new highs in bond yields, comprise our next challenges.

The oversold rally this past week was inspired by the S&P 500 finding key support at the 2,600 level, coupled with some strong earnings reports and hints of some fresh dialogue between the U.S. and China. A couple of Fed presidents also spoke out about how fiscal policy wasn’t a lock to raise rates if economic data softened over the next few weeks. Fear of rising rates boosted the dollar back to its 2018 highs.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For the market to be “out of the woods,” the S&P 500 has to clear 2,765 (its 200-day moving average), and then 2,800 on expanding volume. A favorable outcome in the midterm elections and any sort of framework for constructive talks between Presidents Trump and Xi at the G20 will lay the groundwork for an attempt by the bulls to retake the high ground – as long as the bond market cooperates.

Rising Yields Pose the Biggest Threat to a Year-end Rally

After President Trump berated Fed President Jerome Powell for tightening too fast, the economic calendar delivered a stunning employment report that put the zipper on the President’s concerns and the Fed’s most outspoken critics. The influential Employment Situation report for October showed nonfarm payrolls increasing 250,000, higher than the consensus of just 188,000. Average hourly earnings increased 0.2%, and the unemployment rate remained at a 49-year low of 3.7%.

In short, the strong jobs report validated the labor market trends that will keep the Federal Reserve on a tightening path. The CME FedWatch Tool indicated an 80.7% chance of another Fed rate hike in December, up from a 74.5% chance the previous day. Treasuries sold off along with equities on Friday, pushing yields notably higher across the curve. The Fed-sensitive 2-year yield and benchmark 10-year yield spiked seven basis points each to 2.91% and 3.21%, respectively, compared to 2.81% and 3.08% yields the previous week. The long (30-year) Treasury bond yield jumped to 3.45%. Also, the U.S. Dollar Index added 0.2% to 96.48. The Fed will meet this week, but no rate hike is expected in this meeting.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

So, as the glamour part of earnings season declines, investors will digest the midterm elections and the policy statement that will follow this week’s FOMC meeting. While little attention was given to the bond market last week, I believe it will be a major focus of interest if the Fed maintains their semi-euphoric position on the economy. If so, bond yields risk rising further. While investor sentiment is accepting the recent rate hike and new higher levels for bond yields, a further bump in yields may create headwinds.

Tax reform continues to fuel corporate and consumer spending and will in my view sustain the economy and extend the rally longer than the current consensus expects, as long as the cost to borrow and finance doesn’t push too much on the string of business and consumer budgets. The higher cost of borrowing is acceptable as long as sales and income grow at a faster pace. This is the transitional perception that will become the center of the narrative – as the economic calendar determines how that perception plays out.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license.


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