The Week Ahead: Traders dominate the market right now. Stay on the sidelines
You would think market volatility would have taken off in recent weeks. It hasn’t. The VIX (aka fear) index remains in the 13-15 range and 3-month stock volatility is around 15% against over 20% earlier in the year. The key Ten-Year Treasury was weaker and ended at around 1.84%. Its post-Brexit low reached 1.37% and so has given up about 4% in price over the last few months.
We’re tempted to cut and paste the last few weeks’ commentary because the trading range is the same. The S&P 500 trades at around 2,100, which is where it was in June. These holding patterns are common. The market ran up in the second quarter on expectations of better earnings, low rates and an attractive yield of around 2.1%. The market has delivered on all of those so is poised for the next “big thing”. What is that? Well, looking around this is what caught our eye.
1. Better Growth: The Fed has had its finger over the “raise” button all year. Several concerns have held them back: slower employment growth, Brexit and a miserable first quarter growth. On Friday, the first estimate for Q3 growth came in at 2.9%. Huge sighs of relief because this is what the Fed looks at:
So far so good. But a fifth of the growth was a run down in inventories, which had declined for five straight quarters. We think of inventories simply. If businesses are optimistic, they grow inventories. And if they’re not, they don’t. But part of this quarter’s inventory rebound was simply restocking from very low levels. The other part of the economy that did well were exports, particularly food exports and soybeans. Here they are:
And the way GDP accounting works, which is the rate of annualized change, the food component alone was enough to raise GDP by 1.2%. So, good right? Well, yes but those food exports went to China after a poor harvest in Brazil. Without those numbers, GDP would have been back at the 1.7% rate. Which is pretty much where we’ve been for more than five years. We hope someone at November’s Fed meeting this week speaks up for soybeans everywhere, as in “Yes, Janet, but we shouldn’t raise rates just because, you know, we sell a ton of beans, should we?” Could happen.
2. Sovereign Bonds: We have commented at length on the low yields in the U.S., Germany, Japan, and, pretty much every major developed economy. We’ve also thought that once yield started to climb, that would be a signal of growth, confidence and benign inflation. Now they could also climb because of over-borrowing, bubbles and bad politics. But they have started to move and this is what it looks like (we’ve inverted the scale to make it easier to read):
So pretty much all yields have climbed and bond prices fallen. The explanation for UK bonds falling is simple: post-Brexit trauma and higher GDP. For the U.S. it’s a combination of better trade, capital goods orders, GDP and high Treasury supply. We think U.S. Treasuries will hold at around 1.9%. For Germany, it’s more complicated as bonds started from minus (0.14%). But overrall, this fall back is not a distress signal.
3. Corporate News: A few points as we hit the mid point in earnings:
- Mergers: we’re in the midst of gangbuster merger activity. Three mega deals from AT&T, Qualcomm and BATs account for $130bn alone. We would have expected less in an election year but clearly, companies feel low rates aren’t going to be around for ever so why not some bond-financed buying?
- Earnings: are up around 1.6% which doesn’t sound like a lot but it’s the first positive quarter since Q1 2015. Excluding Apple, which reported earnings down 15%, the rebound would have been stronger.
- Capital Expenditure: is finally improving. Here it is:
The down line is 2015 was nearly all due to a fierce cut back in oil capex. That’s all an improvement from the middle of this year.
Bottom Line: We would expect more distractions up to mid-November. It’s a traders market for now. Big company earnings have the power to move the market. Amazon, Apple and Google proved so last week. This week we have big oil and some key consumer stocks. Meanwhile, we’re keeping our position in TIPS, because we expect more base effect increases in the CPI.
Try your investments skills (some pros don’t do well on this)
Judge says Uber in London as a “mosaic of 30,000 small businesses is faintly ridiculous”.
–Christian Thwaites, Brouwer & Janachowski, LLC
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