Cold Front Blows In: Overseas Weakness Might Hit US As Gold, Bonds See Rise

Pressure from falling overseas markets and a lack of new positive catalysts could weigh on U.S. stocks Wednesday. Defensive investments like gold, the Japanese yen, and bonds all firmed in the early hours.

Though overseas markets generally fell across the board, Japan’s Nikkei deserves special notice because it dropped nearly 2%. Analysts in Asia noted a decline in risk appetite. Some of this could stem from uncertainties surrounding the U.S. budget process, where a government shutdown could take place if Congress doesn’t act by Friday. A stall in Brexit talks between the British government and the European Union earlier this week could be another factor spooking some investors.

U.S. stock futures fell in pre-market trading, and crude oil slipped under $57 a barrel for the first time in two weeks. The S&P 500 (SPX) is down three days in a row for the first time in four months. Last Thursday was the most recent day of gains for the SPX. Meanwhile, gold ticked up from recent four-week lows, and 10-year U.S. Treasury bond yields fell to 2.33% as investors snatched up bonds. This type of trading could signal a bit of risk intolerance.

There’s not much in the way of economic data or corporate news that might help move the market today. Productivity and unit labor costs are about it on the data side, along with a private report on the U.S. jobs picture that came in basically as analysts had expected and the weekly crude oil stockpile numbers. Many investors are in a waiting mode with November payrolls coming up Friday.

It was interesting to see the government continue to peg Q3 productivity growth at a 3% annual rate even as it slashed annualized unit labor costs to negative 0.2%, down from its previous estimate of 0.5% growth. This could contribute to the growing sense that employee pay continues to languish, one possible reason for the weak inflation we’ve seen despite recent economic gains.

Tech shares made a slight comeback Tuesday after getting pummeled the previous session, but everything else turned lower. Info tech was the only sector to rise at all, with all 10 others falling amid a lack of news. With stocks still near all-time highs and valuations running above the historical average, it might take some fresh positive catalysts to get the market climbing again.

Crude oil is at two-week lows ahead of today’s supply report. Last week’s report delivered a mixed picture, with a big drop in crude inventories balanced by a large rise in gasoline inventories. Production continues to post new all-time weekly highs, and that’s helped keep pressure on crude prices despite OPEC’s decision to extend output cuts.

It’s just two shopping days until payrolls, to borrow a seasonal allusion, and the estimates out there don’t look quite as lofty as they did ahead of last month’s report. The official October jobs number was 261,000, but that actually fell below many estimates, some of which had topped 300,000. Looking toward Friday’s report, the average Wall Street estimate stands at just 170,000, according to Briefing.com. That would be roughly average for the year so far, and certainly more than enough to signal an economy that continues to hum along. Unemployment is expected to remain at 4.1%, Briefing.com said.

The report isn’t all about jobs. Wages also come into play, and analysts expect a better showing in that category for November after a flat pay number last month. The average analyst estimate for November has hourly wages rising 0.3%, which would be pretty solid. Keep an eye on year-over-year wage growth as well, which as of October was up 2.4%, vs. 2.9% for the 12 months ended in September. Any big jump in wages would probably get the market concerned about chances of the Fed becoming more aggressive, because higher wages sometimes lead to the economy heating up and potentially lighting some inflation kindling.

Despite the last couple days of struggles, stocks remain near all-time highs and TD Ameritrade’s November 2017 Investor Movement Index^®, or IMX, also hit a new all-time high of 8.53. The IMX had its largest single month increase ever in November—climbing more than 15%—as TD Ameritrade clients were net buyers for a 10^th-consecutive month.

The IMX reading appears to show that investors had continued confidence in the market and wanted exposure to the big rally in November as all three major indices hit all-time highs.

TD Ameritrade clients seemed to take an interest in some volatile blue chips during the November period. AT&T Inc. T was net bought following the U.S. Department of Justice suit to block the proposed AT&T and Time Warner merger. General Electric Company GE also was net bought, as it reached a 5-year low following a dividend cut. Semiconductor and Chinese Internet stocks were other popular net-buys for TD Ameritrade clients during the month, the IMX data showed.

FIGURE 1: NIGHT AND DAY. Looking at gold’s action (candlestick chart) over the last three months vs. five-year Treasury yields (purple line) gives a pretty good sense of the market’s thoughts around tightening interest rates. The yield curve has flattened to multi-year lows as shorter-term yields like the five-year outpace longer-term yields ahead of what’s expected to be a rate hike next week. Meanwhile, gold, which tends to sink when U.S. rates rise, hit four-week lows yesterday. Data source: CME Group. Chart source: The thinkorswim^® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Could Fed Surprise Next Week?

It seems fair to say that few would be surprised if the Fed were to raise interest rates by 25 basis points at its meeting next week. There’s an 85% chance of that, according to the futures market. What might be surprising, though, is if the Fed decides to go even further. Believe it or not, CME futures project about a 15% chance of rates climbing 50 basis points at the meeting instead of a mere 25, though the Fed hasn’t indicated anything of the sort. Such a move, while not unprecedented, seems unlikely, especially if the sideways bond market action this week is any indication. On the off chance that it happens, it’s a little hard to predict how investors might react. Faster tightening might receive an initial bearish read in the stock market because higher rates are designed to slow growth down before inflation takes hold. Stepping back a little, though, it could be seen as a bullish endorsement of a fast-growing economy.

Looking Into 2018

Chances of another Fed hike by March climbed above 60% this week, the futures market indicated, with another hike looking likely by September. One debate now is whether the tax cuts, should they take effect, might speed up the economy enough to get the Fed into even more of a tightening groove. However, most Fed officials who’ve spoken lately, including incoming Chair Jerome Powell, say rates should continue to rise gradually.

Looking out a year from now, futures point to about a two-thirds likelihood that federal funds rate will range between 1.5% and 2%, and no chance at all of rates remaining the same as now or falling below the current range of 1% and 1.25%. That means the market pretty much isn’t pricing in a Fed response to the potential of deteriorating economic conditions in the next 12 months. 

Rushing Into Coverage

Info tech’s slide over the last week met some buying interest Tuesday, which doesn’t come as much of a surprise after the way things have gone all year. The Nasdaq has had several dramatic stumbles in 2017, coming about once a quarter, and each time up until now the market quickly recovered and surpassed its former high levels. It remains to be seen if that happens again, but think about it this way: It’s like playing football. If a team has had success running the ball up the middle over and over, it’s likely to try the same play again. Investors have been successful buying the dips up until now, with the same play working every time. It seems likely they’ll keep trying the same strategy until a big blocker gets in the way. What that might be remains to be seen.

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