Rollover Rally: Raytheon/United Technologies Merger Key Weekend Development

This week is starting off where last week left off, with more strength as geopolitical issues seemed to favor the bulls.

The big kahuna is President Trump’s decision over the weekend to suspend his proposed tariffs on Mexico. That’s a relief for many of the Industrial companies, particularly automakers, which might have faced trouble under the proposed tariff regime.

European and Asian stocks led the way higher early Monday, with another boost coming from better than expected Chinese export data. There seems to be a bit of a “risk-on” sentiment taking the wheel this morning, with U.S. Treasuries stepping back and the yen—another so-called “defensive” area—falling as well. We’ll have to see if this holds up, because if it does it could signal more strength for the cyclical sectors like Info Tech and Consumer Discretionary that tend to rise when the economy is rolling along.

Just like last week, the question is whether the momentum can continue. It’s still pretty early, but some of the names that racked up big gains over the last few sessions continued to move ahead in pre-market trading Monday, notably Beyond Meat Inc BYND up another $14 in pre-market trading. The market overall looks pretty healthy.

In corporate news over the weekend, the big development was an announcement that Raytheon Company RTN and United Technologies Corporation UTX plan to merge. If the merger goes through, this would be the world’s second-largest aerospace and defense company behind Boeing Company BA. Shares of RTN, UTX and BA all rose in pre-market trading.

There was also a $15.7 billion deal in which Salesforce.com, Inc. CRM will buy Tableau Software Inc DATA. Shares of DATA scurried to 34% gains in pre-market trading Monday.

The takeaway here might be that low interest rates continue to make it affordable for companies to do merger and acquisition (M&A) activity. 

Key inflation data—especially consumer prices on Wednesday—form the core of this week’s economic reports. The other big report to consider watching is retail sales for May on Friday. The May jobs report pointed to some economic softness, so will inflation and retail sales back that up?

New Strength Follows 4% Rise Last Week

The week that turned around a month-long string of Wall Street losses didn’t simply end the losing streak—it shattered it. In just the four sessions from last Tuesday to last Friday, the S&P 500 Index (SPX) rallied more than 4% to post its best weekly showing of 2019. It’s now just 2.6% below the all-time high set in April.

Last week’s performance might be evidence of pent-up demand for stocks after the May market flop. That trend accelerated last Tuesday after Fed Chair Jerome Powell seemed to hint the Fed might be ready to lower rates if necessary to support the economy. Even though trade issues haven’t gone away, there’s a feeling that the Fed could have the market’s back.

Let’s keep things in context, however. A rally that happens when there’s good news is one thing, but the one we’re in now isn’t necessarily as solid. 

Some people look at this rally with a bit of a fish-eye, because it seems like the economy is slowing. Friday’s May jobs report showed just 75,000 new positions added, about 100,000 below Wall Street’s expectations and another sign—along with recent tepid manufacturing data—that there could be some trouble brewing on Main Street.

The market’s got a conundrum here. The jobs report wasn’t good, so just based on the report itself, it would seem people might want to sell stocks. However, the fact that the report arguably makes the case for a rate cut could be why the market hung in so well on Friday.

Rate Cut Odds Soar for July Fed Meeting

Early Monday, futures prices indicated odds of around 80% that the Fed would cut rates at its July meeting. Just a few weeks ago, in contrast, the market signaled low chances of a cut until later this year. Though a rate cut at the June meeting looks less likely at 17%, according to futures, it can’t be ruled out. Some investors even think the Fed could cut rates by 50 basis points by the end of next month.

The question is whether the market can build off of this momentum, which was based on negative economic news. Some signs point to potential continued strength, including the SPX’s close Friday above the 50-day moving average near 2870 and the strong trading volume we saw parts of last week. This wasn’t one of those thin volume rallies that makes you doubt the market’s conviction.

Still, the logic doesn’t completely make sense, and a couple of things about Friday seemed disconcerting. First, the Financial sector fell, and it’s often said it’s hard to have a rally without the big banks. The second caution flag, and a related one, is the continued strength in Treasuries. Ten-year yields ended the old week near 2.08%, around their lowest levels since the fall of 2017, as some investors continued to take a “risk-off” strategy. The lower rates might have given Financial stocks a tough time Friday.

Disconnect Develops

Utilities, usually a sector that gathers strength in a falling rate environment as investors look for yield, was the surprise sector weakling Friday. At this point, there seems to be a disconnect between stocks and bonds. Usually when bonds get a bid, stocks fall. Usually when yields fall, dividend stocks like Utilities rise. The opposite happened on Friday.

What it looks like is that many people want to be exposed to stocks amid pent-up demand and beliefs that this rally can continue. It’s probably too early to count out Utilities for dead, though, just because they didn’t rally on falling yields Friday. It might be interesting to see how things progress in the new week.

Another thing to consider watching this week as the Fed prepares for its June 18-19 meeting is inflation data Tuesday and Wednesday. If the data look strong, that might conceivably push back thoughts of a quick rate cut. However, inflation hasn’t been much of a factor lately, so it’s possible that even if the May numbers come in on the high side, the Fed might decide one month isn’t enough to worry about.

May producer prices are due early Tuesday, and Briefing.com’s consensus is for a 0.2% rise in the headline number and a 0.3% increase in the core, which strips out energy and food costs. Core producer prices rose just 0.1% in April, so this would be a decent acceleration. The yearly increases in April were 2.2% and 2.4%, respectively, for headline and core, and didn’t raise many eyebrows at the time.

FIGURE 1: DISCONNECT THE DOTS: While the 10-year U.S. Treasury yield (candlestick) kept getting hit last week, Utilities (purple line), couldn’t continue their upward momentum Friday. This was a conundrum, because dividend-yielding sectors like Utilities generally do well when Treasury yields fall. We’ll see if it was a one-day affair or if there’s more to this as the week continues. Data Source: S&P Dow Jones Indices, Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Weak Jobs and the Consumer: The jobs number for May was soft, and the government also cut its estimates for March and April payrolls growth by a combined 75,000. This could put more importance on some of the coming economic data that reflect consumer health, like retail sales and housing. Judging by how stocks performed Friday, a lot of investors are pinning their hopes on belief that there’s nothing to see here, but if consumer data soften, it could point to the weaker jobs growth starting to have a negative impact. We’ll have to wait and find out.

Arguably the biggest concern right now is whether the consumer can stay healthy. One of the best-performing sub-sectors last week was the payments industry, with stocks like MasterCard Inc MA, Visa Inc V, and PayPal Holdings Inc PYPL all making big statements Friday. These three names, which Barron’s calls the “MVPs,” could continue to be worth watching in coming days to see how much faith the market has in consumer health. That’s because when consumers are out spending or online spending, they tend to take out those cards more.

Nasdaq Outpaces: For most of last week it was the so-called “cyclical” sectors leading the parade. These are ones like Info Tech, Consumer Discretionary, and Communication Services that tend to perform best in a strong economy. The Nasdaq (COMP), which is heavily loaded with Info Tech stocks, is by far the leading major index this year, up nearly 17% going into the new week vs. 14.6% for the SPX and 11.4% for the Dow Jones Industrial Average DJI. The COMP handily outperformed its cousins on Friday with an impressive daily gain of 1.66% vs. just over 1% for the other two.

Technical Talk: It’s kind of hard to believe considering where the market was a week ago, but the S&P 500 Index (SPX) easily carved through its 50-day moving average Friday, at around 2870. This comes after the SPX fell below its 200-day moving average of around 2775 a little over a week ago, and looks like a very bullish pattern on the charts. The brief dip below long-term technical support at 2750 early this month didn’t last long, and that level—which has served as a pivot point for the SPX over the last 17 months or so—could be one to consider watching if things go south again anytime soon. Meanwhile, 2900 might be the resistance point up above.

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