Tech stocks took a break last week—surrendering their star role as the third-quarter earnings season kicked into gear. They were up 1.3%, only the third-best sector performance, trailing real estate, up 1.8%, and consumer staples, up 1.5%.
The Dow Jones Industrial Average closed at 22,871, up 0.43% on the week, and the Standard & Poor’s 500 index gained 0.15%, closing at 2,553. The Nasdaq Composite, which rose 0.24% to finish the session at 6,605, set another all-time high.
Binky Chadha, chief U.S. and global equity strategist at Deutsche Bank, described the weekly action as “a modest grind higher.”
The Russell 2000 Index, a bellwether for small-cap stocks that had made big gains from mid-August through the end of September, bucked the trend and closed the week at 1,502, down half a percentage point.
The 10-year U.S. Treasury ended the week yielding 2.28%, the third trading session out of the previous four that investors bid up prices. (Bond prices move in the opposite direction of yields.) Inflation expectations for the next 12 months fell to 2.3% from 2.7% a month earlier, according to the University of Michigan Consumer Sentiment Survey. Lower inflation is less of a threat to fixed-income yields and makes it harder for the Federal Reserve to raise rates again in 2017.
Still, says Chadha, “Our call is that inflation will move up and bond yields will go higher,” adding that the firm forecasts the 10-year Treasury will yield 2.75% at the end of this year, about half a percentage point above where it was late last week.
Even though the large-stock indexes ended the week in positive territory, they didn’t make the big moves they have in recent weeks, as evidenced by gains of half a percentage point or less.
The week served as a breather for many stocks, says Frank Cappelleri, a technical analyst at Instinet, a subsidiary of Nomura. “I don’t think it’s a surprise to anyone to see some of these moves being digested,” he says.
After another week of strong gains for stocks, the fear of missing out could drive this bull market even higher.
Last week, the Dow Jones Industrial Average climbed 368.58 points, or 1.6%, to 22,773.67, its fourth consecutive week of gains. The Nasdaq Composite gained 1.5% to 6590.18, a record high, while the Standard & Poor’s 500 index rose to 2549.33.
And what well-earned gains they were. Early last week, the Institute for Supply Management’s manufacturing index hit 60.8, its highest level since 2004. That was followed by better-than-expected jobless claims and durable goods orders on Thursday. Even Friday’s weaker-than-expected payrolls report could be explained away due to the hurricanes that hammered the country during September. Looking ahead to next week, September’s consumer-price-index data could provide more evidence of a not-too-hot, not-too-cold economy.
“Generally, fundamentals look good,” says Greg Woodard, portfolio strategist at Manning & Napier. “We expect the expansion to continue at slow rate.”
Speaking of slow: The S&P 500 has now gone 332 days without a 5% drop, second only to the 333-day rally that began on Nov. 23, 1994, notes William O’Neil strategist Randy Watts. (Yes, that means that if we make it through Tuesday without a selloff, it will be the longest such streak on record.)
The rate of the change, however, has been downright snail-like, with the market rising about 33%, or just under 0.1% a day, over the course of the rally. During the rally that began in 1994, the market gained about 58%, or 0.17% a day. “It’s rare to go this long without a correction,” Watts says. “But the economic recovery has been more muted than in the past.”
Even so, are investors getting too complacent? Bank of America Merrill Lynch’s sell-side indicator, which tracks optimism among Wall Street strategists, remained at 55.4 in September, near its highest level since 2011. Using a 15-year average, that’s nothing to worry about—the market has been higher 12 months later 61% of the time following such readings. But switch to a four-year time average and it’s more worrisome, with a drop occurring 49% of the time. “Sentiment levels are now at relative levels that have historically indicated weak returns over the next 12 months,” says Merrill Lynch strategist Savita Subramanian.
But that’s so 12-months-from-now. Wellington Shields technical analyst Frank Gretz points out that bull markets generally see a “blowoff” move from at least one market sector before all is said and done. He points to 2007 and the rally in oil stocks—the energy sector gained 32% that year as the market was topping—and I’d add the tech sector’s 78% rise in 1999.
The market should be facing a disaster of biblical proportions.
We have hurricanes and earthquakes, a nuclear-armed dictator in North Korea threatening to unleash fire and brimstone, and yes, even a Republican president working with Democrats in Congress. Or as Bill Murray put it in Ghostbusters, “Mass hysteria!”
Not quite. Despite the suffering brought by a trifecta of natural disasters, and the shock of seeing President Donald Trump teaming up with Nancy Pelosi to extend the debt-ceiling deadline, only nuclear tests by North Korea really shook the markets. And even then, it wasn’t much of a shock. The Standard & Poor’s 500 index declined just 0.6%, to 2461.43, last week, while the Dow Jones Industrial Average fell 189.77 points, or 0.9%, to 21,797.79. The Nasdaq Composite dropped 1.2%, to 6360.19. Despite the declines, the S&P 500 sits just 0.8% below its all-time high.
Why have stocks held up as well as they have? Dubravko Lakos-Bujas, head of U.S. equity strategy and global quantitative research at JPMorgan, observes that the S&P 500 has dropped about 2% when hurricanes make landfall, as sectors that get slammed—think insurance companies, hotels, and cruise lines—are offset by ones that benefit, like autos, energy and equipment services, and basic materials for construction. A failure to raise the debt ceiling or pass a budget, though, has typically caused the market to drop 3% to 5%. “In essence, the market risk associated with the failure of passing the budget and addressing the debt ceiling has been pushed out for now,” Lakos-Bujas says.
There’s another reason for optimism: earnings. Yes, we know that second-quarter earnings season just ended, but investors are already looking ahead to the third quarter. And despite some recent negative guidance associated with Hurricane Harvey, earnings revisions appear to be holding up well. Bank of America Merrill Lynch strategist Jill Hall notes that the three-month earnings estimate revision ratio—a measure of companies guiding higher versus those guiding lower—sat unchanged at 1.23 at the end of August, its highest level in six years. “It suggests strong near-term S&P 500 returns,” she says.
More importantly, that means earnings expectations aren’t coming down. Andrew Slimmon, a portfolio manager at Morgan Stanley Investment Management, notes that earnings forecasts generally drop by about 7% from the start of the year. But with earnings coming in close to expectations, the market might start viewing next year’s S&P 500 earnings estimate for $145 as achievable. At Friday’s close, that puts the index’s valuation at a more reasonable 17 times earnings. “I don’t think that’s all that expensive,” Slimmon says. “We have a setup for a decent rally in the fourth quarter.”
Of course, not everyone is ready to buy into such arguments. For them, the market’s strength is simpler. “It’s a bull market,” says Vincent Deluard, global macro strategist at INTL FCStone Financial. “Good news is celebrated; bad news ignored.” Until it isn’t.
Remember the days of risk on/risk off? Well, welcome to the world of Trump on/Trump off.
The market, remember, had been in the throes of a two-week losing streak, one that had a lot to do with what President Donald Trump said. Last week, that streak came to an end because of what his administration might do. On Tuesday, reports of progress on tax reform helped push the Standard & Poor’s 500 index up 1%, and while the major benchmarks stalled after the president called for a government shutdown if money wasn’t allocated for a border wall, it rose 0.2% on Friday as tax reform became the focus once again. “That helped underpin the market,” says Quincy Krosby, chief market strategist at Prudential Financial.
And underpinned it was. The S&P 500 finished the week up 0.7% at 2443.05, while the Dow Jones Industrial Average rose 139.16 points, or 0.6%, to 21,813.67. The Nasdaq Composite gained 0.8% to 6265.64.
Don’t be surprised if the market bounces back and forth as the focus shifts between pro-growth policies such as tax reform and deregulation, and fears of a debt-ceiling standoff or a government shutdown. Keith Lerner, chief market strategist at SunTrust Advisory Services, observes that while a shutdown has an economic impact, it’s more like a winter storm, and the effect is generally short-lived. There have been 18 shutdowns since 1976, he says, with the S&P 500 dropping 0.6%, on average, when the government is closed. The largest decline—a 4.4% drop—came in 1979 when President Jimmy Carter vetoed a bill that included funding for a nuclear-powered aircraft carrier. The takeaway: “Political showdowns tend to be short-lived and generate little permanent effect on the stock market,” he says.
Still, a standoff over the debt ceiling or budget would come at an inopportune time. Despite the S&P 500’s rally last week, the percentage of stocks trading above their 200-day moving average dipped below 50% early last week, a sign that “fewer stocks are supporting the overall index,” says Thomas Lee, head of research at Fundstrat Global Advisors. That’s happened 24 times since 1996, Lee says, and in 23 of those cases the S&P 500 fell to just below its own 200-day moving average. That suggests the S&P 500 could drop to 2300, Lee says, down around 6% from Friday’s close. If something goes wrong with tax reform or other policy issues, it could be just the catalyst the market needs for a selloff. “It’s unpredictable,” Lee says. “We don’t know how the market will react to anything.”
Federal Reserve Chair Janet Yellen’s speech at Jackson Hole, Wyo., was supposed to be the event of last week, but instead was overshadowed by tax-reform talk. But make no mistake: The Fed is still looking to shrink its balance sheet, and even hike interest rates again this year. This Friday’s U.S. payrolls report could go a long way toward determining whether the Fed will sit on its hands—as the futures market is currently predicting—or keep on tightening. “It could certainly push up the odds for a hike in December,” Prudential’s Krosby says.
And that, of course, would bring risks of its own.
It’s locked and loaded. Are we referring to the U.S. nuclear arsenal, or the stock market?
President Donald Trump found a way this past week to get under the market’s skin with his colorful comments directed at North Korea leader Kim Jong-un. The president promised to unleash “fire and fury,” then claimed that the U.S. military was “locked and loaded” and ready to respond to any provocation.
News that North Korea had been able to build a nuclear warhead small enough to place atop a missile likely would have sunk the market anyway—and sink, it did. The Dow Jones Industrial Average declined 234.49 points, or 1.1%, to 21,858.32 on the week, its largest one-week slide since March. The Standard & Poor’s 500 index fell 1.4% to 2441.32, and the Nasdaq Composite dropped 1.5% to 6256.56.
But pardon us for not quaking in our boots—at least when it comes to the market. Geopolitics has a way of shaking stocks, but rarely does the damage last. The S&P 500 dropped 1.1% the day Iraq invaded Kuwait in 1990, according to Strategas Research Partners data. The index fell further in the next three months, but was up 10% 250 trading days later. Even the Cuban Missile Crisis in 1962 resulted in only a 6%-plus drop that was quickly erased. “It’s a serious situation,” says Brad Neuman, investment strategist at fund-manager Alger. “But your best bet was to stay in equities.”
Stocks are driven by economic growth. For a geopolitical event to derail a bull market, it would have to hamper the U.S. economy as well. That’s very unlikely.
Ah, yes, the economy. As has been the story since President Trump’s election, confidence remains high. The NFIB Small Business Index rose to 105.2 in July, while the actual data remain sluggish. Productivity rose just 0.9% during the second quarter, and the consumer price index advanced just 1.7%, missing estimates for 1.8%. None of that is exciting, but it doesn’t point to a recession either—the one thing guaranteed to bring a bull market to its knees.
Newton’s third law of physics states that for every action there is an equal and opposite reaction—but sometimes that can lead to no action at all.
Take the so-called FANG stocks. Three of the four reported earnings last week, with Facebook (ticker: FB) gaining 4.9% last week, Amazon.com (AMZN) slipping 0.6%, and Google parent Alphabet (GOOGL) dropping 3.6%. In the end, they netted out to a 0.2% decline to 6374.68 for the Nasdaq Composite, and virtually no change for the Standard & Poor’s 500 index, which closed the week up 0.4 point at 2472.10.
The Dow Jones Industrial Average was the exception that proved the rule. With none of the FANGs among its 30 component stocks, the blue-chip benchmark rode huge gains in Boeing (BA) and Caterpillar (CAT) to a 250.24 point, or 1.2%, gain to 21,830.31, an all-time high.
Still, it’s hard to ignore just how on edge the market seems to be, as every drop, no matter how small, is analyzed for signs that it’s the one that marks the end of the long bull market. And every gain is an opportunity for handwringing. The muted CBOE Volatility Index, or VIX, which traded as ridiculously low as 8.8 last week, has only added to the consternation, prompting talk that a tumble is looming.
“There’s a sense that many things are coming together that make you feel like you’re headed for a correction,” says Jim Paulsen, chief investment strategist at the Leuthold Group. “There’s so much of that right now, that it almost would surprise me if it happens.”
And for good reason. The S&P 500 has suffered two 15% drops since the bull market got going in earnest, says Tony Dwyer, chief market strategist at Canaccord Genuity. The first occurred in 2011, when the European Central Bank raised interest rates as it wrestled with its own financial crisis and the global economy struggled to grow again. The second occurred at the end of 2015 and into 2016, when China’s currency depreciation and the collapse in oil prices caused markets to tumble. Dwyer sees few similarities today. The global economy continues to recover, and U.S. gross domestic product grew at a 2.6% clip during the second quarter; earnings are growing at a 10%-plus clip; and a weak dollar should provide a boost for U.S. multinationals and commodity prices. “This will end badly at some point,” Dwyer says. “But the underpinnings for a major drop are just not there right now.”
Which doesn’t mean there won’t be sudden bouts of volatility. Two events in particular have the potential to shake things up. On Friday, we’ll get the June payroll data, which could provide evidence of whether the Federal Reserve, which left interest rates unchanged last week, is ahead of or behind the curve. And then there’s Apple (APPL), which is scheduled to release earnings on Tuesday—and this time the Dow won’t be above the fray. A surprise from either could upend stocks.
Just don’t bet on it. “The market appears bulletproof,” says Ian Winer, head of equities at Wedbush Securities.
Weebles wobble but they don’t fall down—and the same might be said of the stock market.
There was certainly a lot of wobbling, as the Nasdaq Composite, in particular, threatened to break down. The tech-heavy benchmark rose 0.2% to 6,135.08 last week despite closing on Thursday at its lowest level since May. The Dow Jones Industrial Average rose 64.71 points, or 0.3%, to 21,414.34, while the Standard & Poor’s 500 index ticked up to 2425.18.
Low bond yields and central-bank asset purchases have tamped down volatility in both the economy and the market, says Evercore ISI strategist Dennis DeBusschere, and that, in turn, has helped increase stock valuations. How much of a boost valuations have gotten, however, is unknown. The upshot: “That unwinding process runs the risk of increasing volatility and increasing headwinds for the market multiple,” DeBusschere says.
That doesn’t mean the market needs to drop, but it does put the onus on profit growth. With rates rising and multiples under pressure due to tighter monetary policy, it might take more than your run-of-the-mill earnings beat to send stocks higher, says UBS strategist Julian Emanuel, who will be closely watching Friday’s bank earnings; Citigroup (ticker: C), JPMorgan Chase (JPM), and Wells Fargo (WFC) are set to release. How the stocks react could go a long way toward determining whether the market can continue to push higher. “Friday could be the most important trading day of the year,” Emanuel says.
We got a preview of how that could play out last week, when Costco Wholesale (COST), which trades at 24.7 times 12-month forward earnings, reported what appeared to be top-notch same-store sales, but fell 2.5% over the last two days of the week.
The good news is that the weaker-than-expected economic data that seemed to be a permanent part of the landscape appear to have finally started to turn upward. Last week, for instance, the U.S. economy added 45,000 more jobs than predicted, says HighMark Capital Management Director of Research Todd Lowenstein, while the Institute for Supply Management’s manufacturing and services indexes were both stronger than expected. But more of that will be needed. “We could be stuck until the weight of data kicks in,” he says.
Most of us have been asked at some point if we would jump off a bridge if all our friends did. Last week, the market demonstrated what happens when investors answer “yes.”
Stocks were quietly heading toward new highs Friday morning when Apple (ticker: AAPL), Alphabet (GOOGL), Facebook (FB), and other tech names suddenly fell. By the close, each had lost more than 3%, while the tech-heavy Nasdaq Co mposite had dropped 113.85 points, or 1.8%, to 6207.92. Stranger still, the S&P 500 declined by less than 0.1%, to 2431.77, while the Dow Jones Industrial Average rose 89.44 points, or 0.4%, to 21,271.97, a new all-time high. (The three benchmarks finished the week down 1.6%, down 0.3%, and up 0.3%, respectively.)
What sparked the tech wreck? Some market participants pointed to a Goldman Sachs report that circulated Friday highlighting an increase in “mean-reversion risk” for FAAMG stocks—a quintet of highflying names including Facebook, Amazon.com (AMZN), Apple, Microsoft (MSFT), and Google parent Alphabet. Then there was a report from noted short seller Andrew Left, of Citron Research, targeting chip maker Nvidia (NVDA), whose shares have surged 50% this year. Friday, they fell 6.5%, to $149.60.
More likely, the problem was love. Tech stocks have been the object of investors’ ardent affection for much of this year, to the exclusion of much else, and too much love can be a dangerous thing. At the end of May, three of the fourth most “crowded” large-cap industry groups hailed from the information-technology sector, according to Credit Suisse strategist Lori Calvasina, who tracks sell-side stock ratings, stocks overweighted in mutual funds, and hedge fund net exposure to find industries that appear over-owned. While tech stocks have attracted an abundance of buyers for a while, which has pushed prices up, Calvasina says she has noticed a change in the tone of conversations around the group. “People have been getting more concerned” about the stocks’ popularity and valuations, she says.
Calvasina downplays the risk, however, that large-cap tech prices will reach bubble proportions, as happened in the year leading up to the 2000 dot-com crash. The reason: Tech is nowhere near as expensive as it was at the 2000 peak. In fact, it isn’t even as expensive as the health-care sector was in 2015, when she lowered her health-care rating to Sell from Neutral. “You don’t have a valuation problem,” she says of tech.
Even as investors dumped the FAAMGs and their cousins, they were snapping up financial and energy shares, which helps to explain the Dow’s and S&P’s seeming obliviousness to the carnage next door. The S&P 500 Financial Index rose 1.9%, while the S&P 500 Energy Sector climbed 2.5%. Financials and energy have gone begging for love this year; they have been two of the worst performers. “A lot of stocks were being looked over,” says Rhino Trading Partners Chief Strategist Michael Block. “You see how everyone is positioned and go the other way.”
The banks also benefited, following former FBI Director James Comey’s testimony on Thursday, from a sense that President Donald Trump’s policy goals might not be dead on arrival after all, a point driven home when the House of Representatives passed a bill that would roll back many of the financial regulations passed in the wake of the financial crisis, says Jason Ware, chief investment officer at Albion Financial Group. He says that banks would also benefit if longer-term bond yields start to rise relative to short-term rates. This is known as a steepening yield curve.
Whether that happens could have much to do with the Federal Reserve’s decision on interest rates at its monetary-policy meeting this week. Financial stocks are among the bigger beneficiaries of higher interest rates, especially when longer-term Treasury yields rise with them. The Fed is widely expected to raise rates another quarter of a percentage point on Wednesday. If Fed chief Janet Yellen can pull off a hike and convince markets that the U.S. economy is still growing steadily, Friday’s tech wreck could be just a hiccup on the way to higher stock markets.
The bull case for stocks took its biggest hit of the year last week, but nothing seems able to prevent this market from reaching new highs.
The Dow Jones Industrial Average advanced 12.01 points, or 0.6%, to close at 21,206.29, while the Standard & Poor’s 500 rose to 2439.07. The Nasdaq Composite gained 1.5% to 6305.80. All three indexes closed the week at record highs.
This comes despite economic data that cast shade on what has kept many an investor bullish on stocks this year. Despite the death of the so-called Trump trade—the idea that stocks would get a boost from tax cuts, fiscal spending, and deregulation—optimistic investors could always point to a potential pickup in economic growth, even without policy action. Friday’s payrolls report, which showed that a mere 138,000 U.S. jobs had been created in May, wasn’t exactly fatal for that view, but it certainly presents a quandary.
“This is more worrisome than the twist and turns of politics,” says Morgan Stanley Investment Management portfolio manager Andrew Slimmon.
Still, the Federal Reserve Bank of Atlanta’s closely watched GDPNow forecast model is predicting second-quarter economic growth of 3.4%—none too shabby, unless compared to the 4% growth it was predicting the day before the payrolls data were released. Slimmon says he’ll be watching closely to see if that number rises or falls as new data are released in the coming weeks. “We need data that validate 3% GDP growth, or the market will go nowhere,” says Slimmon, who remains optimistic about future gains.
What alternative do investors have? The 10-year Treasury note yields just 2.16%. With payouts that meager, stocks still possess their charms, especially when the U.S. economy continues to grow modestly and the rest of the world looks stronger, says Manning & Napier senior analyst Greg Woodard. “Equities seem to be a reasonable investment,” he says. “The path of least resistance” is for stocks to go higher.
That may be less worrisome than it sounds. Doug Ramsey, chief investment officer at the Leuthold Group, notes that the market’s rally is quite broad, despite concerns that too many of the recent gains have come from giants like Apple (ticker: AAPL) and Amazon.com (AMZN). He notes that it’s not just the Dow industrials, the S&P 500, and the Nasdaq Composite that are hitting new all-time highs, but that the Dow Jones Composite Average and the Dow Jones Utilities Average are as well, while the Dow Jones Transportation Average and the small-company Russell 2000 are within a stone’s throw of theirs.
Even the advance/decline line, a measure of advancing stocks versus declining ones, is sitting at a record high, something that has historically meant that a bull market has at least another three to six months to go. Ramsey says he wouldn’t be surprised if the S&P 500 hit 2,600 before the end of the summer, even if he can’t offer a reason why.
“I tend to like rallies that are somewhat mysterious,” he says. “It means that the market is [anticipating] good news that we’ll read about weeks or months down the road.”
It’s just a question of what that good news will be.
If a scandal breaks out in Washington, and the market doesn’t react, did it really happen?
The scandal, of course, was the abrupt firing of FBI Director James Comey last week, which provoked an outcry from Democrats—and even a few Republicans—but was dismissed by President Donald Trump as the removal of a “showboat.” The headlines continued throughout the week—some even drew comparisons to Richard Nixon—but stocks couldn’t be bothered to respond one way or the other. “The market is telling you it’s background noise,” says TD Ameritrade strategist JJ Kinahan.
It certainly was another yawner despite the pyrotechnics in Washington. The Dow Jones Industrial Average fell 110.33 points, or 0.5%, to 20,896.61 last week, while the Standard & Poor’s 500 index declined to 2390.90. The Nasdaq Composite rose 0.3% to 6121.23. The CBOE Volatility Index, or VIX, closed at 10.41 after falling into the single digits earlier in the week.
It wasn’t all quiet. Retailers such as Macy’s (ticker: M), Nordstrom (JWN), and J.C. Penney (JCP) suffered double-digit losses after releasing earnings, but warns Daniel Chung, CEO of asset manager Alger, don’t blame their disappointing sales on consumer weakness. “It’s the internet, not [a lack of] consumer strength,” he says. As if to serve as confirmation, retail sales grew at a 0.4% clip last month, weaker than the 0.6% that economists had predicted, but not low enough to worry.
