Yellow "Caution" Flag Waving After Sharp Move Lower As Geopolitical Risks Remain

In auto racing, a yellow flag warns drivers to be cautious. Investors might also be seeing yellow this morning after yesterday’s sharp move lower. Nearly every sector got smacked around Tuesday as worries about North Korea took their toll.

Look for cautious trading. The last few times we’ve had this type of situation, the market rallied back quickly, so many market participants may be reluctant to commit one way or the other in early action.

Tuesday’s trading, in which all major indices came under pressure and the S&P 500 was off more than 1%, reinforces some things we’ve spoken about. First, the primary risk to the market at this juncture remains geopolitical, and the noise in Washington, D.C., remains just that: noise.  By the way, the debt ceiling talks are real, but the first few weeks will be noise until things get serious. Congress has until Sept. 29 to act.

The second thing this reminds us about is the importance of perspective. Yes, the market was ugly yesterday. However, the slide represented a 1% move just off of all-time highs. We haven’t had a good-sized down day in a while, but to listen to some market commentators, you would have thought it was Armageddon. Now going forward this is a fluid situation and not a time to be lulled to sleep. Investors should be vigilant in making sure their portfolios reflect their current needs as well as risk levels they’re comfortable having. 

Looking back at Tuesday, only energy and utilities escaped the pounding. Financials took the biggest beating, falling more than 2% as yields on benchmark 10-year Treasury bond sank to their lowest levels of the year, below 2.07%. Financials are now the third-worst performing sector over the last month (see below) and lag most other sectors year to date. Lower yields tend to weigh on financial names, and insurance companies are under pressure from worries about Hurricane Irma, which is spinning into the Caribbean and might be headed toward Florida.

Basically, investors seemed to run for safety wherever they thought they could find it Tuesday, VIX ran up a 38% intraday gain. Gold hit a high for the year (see chart), but VIX leveled off a bit by the end of Tuesday to fall back below 13 and continued to track downward early Wednesday. It’s still relatively low by historic standards, but way above where it closed last week. The dollar, meanwhile, found itself under pressure and near 2017 lows amid media reports that Fed Governor Lael Brainard had said inflation is “well short” of target. Brainard also expressed caution about raising rates.

Keep in mind that the economy appears to be holding up pretty well, with last Friday’s jobs report showing strength in areas like construction and manufacturing. We also saw TD Ameritrade’s August 2017 Investor Movement Index^® climb to a new all-time high in August of 7.45. Clients’ decisions to continue buying seem to reflect the resiliency of the markets, even in the face of geopolitical tensions. As geopolitical strife resulted in worldwide volatility, investors appeared to find additional buying opportunity in market pullbacks and positive earnings reports.

S&P 500 Index (SPX) futures were hugging the flat line in pre-market trading Wednesday, with pressure continuing from Asia, as Japan’s Nikkei hit a four-month low overnight.  We continue to monitor the impressive rally in gold as the precious metal is near a 52-week high and has rallied more than $100 since mid July. Today brings trade numbers and PMI this morning and the Fed’s Beige book this afternoon.

FIGURE 1: GOING FOR THE GOLD Geopolitical concerns had many investors rushing to buy gold on Tuesday, sending futures to their highest levels of the year. At the same time, VIX (purple line) rose 38% at one point before ending the day a little below its highs. Uncertainty keeps bringing investors back to gold this year, but the pattern so far has been for sell-offs after new highs. We’ll see what happens this time. Data sources: CBOE, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Tracking Transports

After peaking in mid-July, it’s been a downhill ride for the Dow Jones Transportation Average (DJT), which fell with the rest of the market Tuesday but has been lagging for a couple of months now. Transports — which include shares of airlines, trucking firms, and railroads, among others — can often give insight into the economy as a whole. When transports sputter, it could mean declining demand for some of the products these companies ship. The DJT is down more than 4.5% since July 14, when it set an all-time high. On the positive side, however, nondefense capital goods orders excluding aircraft — often considered a proxy for business spending — increased 1% in July, Briefing.com noted. 

Financials On Defense As Bonds Spike

Another sector on the decline lately is financials. That partly reflects insurance companies facing another hurricane, but low bond yields play a role, too. Financials are now the third-worst performing sector over the last month, with only energy and telecom trailing. It’s often said that it’s hard to have a big rally without the participation of big banks, so we’ll see if that proves the case as September rolls along or if financials can find a way to come back. The Fed meeting in a couple weeks could have an impact on the sector, especially if the Fed announces any plans to start its balance sheet trimming. On the other hand, if the geopolitical situation remains unsettled, that could keep bonds supported and point to a bearish scenario for financials. Watch the path of Irma, too, for a sense of how it might affect the insurance industry.

Short Week Brings Key Data, Reports

Keep your eyes open today for weekly crude oil inventories and the Fed’s Beige Book. The crude supply situation might be interesting due to the hurricane, which shut down a good deal of production over the last two weeks. On the other hand, refineries were idle, as well, so it’s possible a lot of oil sat around not being utilized. That might mean less of a draw than the 5.4 million barrels taken out of storage the previous week. This is also the traditional end of “driving season,” so oil inventories might start creeping higher from here on, adding to a global supply situation that’s pretty heavy. Oil prices moved higher early Wednesday as refineries re-opened, raising demand. There’s also concern about Irma’s possible impact on Gulf of Mexico oil production.

The Fed’s Beige Book isn’t normally a big event, but it might take on some extra significance this time around as the Fed seems to be at a bit of an impasse on what to do next and when to do it. The health of regional economies could help determine the Fed’s next steps on rates and the balance sheet.