What Trade War? Positive Sentiment Seems To Continue From Friday

Following Friday’s big rally, the new week begins with a positive tone as trade concerns that dogged the market over the last month continued to recede a bit. Solid gains in Europe and Asia overnight also appeared to give U.S. stock futures a boost in the early going Monday.

Earnings season gets underway again Friday as three of the big banks step up to the table with their Q2 results, and before that brace yourself for some important inflation data. In addition, the market continues to digest last Friday’s better than expected June payrolls report, which seemed to offer something for just about everyone.

Get Ready: Earnings Season Almost Here

Friday is the first real day of the new earnings season as JP Morgan Chase & Co. JPM, Wells Fargo & Co. WFC, and Citigroup Inc. C open up their books for investors that morning. The financial sector has had a tough year so far, down more than 4 percent compared with a better than 3 percent year-to-date rise for the S&P 500 Index (SPX). A lot might play into this, including stubbornly low long-term Treasury yields that can weigh on banks’ profits. As always, the post-earnings calls could be as interesting as the numbers themselves, potentially offering key observations from financial industry leaders who tend to have their fingers on the pulse of the economy. 

Earlier in the week come some data that the Fed is likely to watch closely: Producer and consumer prices for June. Producer prices are due early Wednesday followed by consumer prices early Thursday. Inflation has stayed pretty tame most of the year, though the Producer Price Index (PPI) rose a moderate 0.5 percent in May due in part to higher energy prices. We’ll look more closely at analysts’ estimates for the two inflation reports in the coming days.

Old Week Wrapped Up on Strong Note

Wall Street posted gains last week as Friday’s June payrolls report appeared to indicate continued economic strength. With 213,000 new positions last month, employers have now added jobs for 93 straight months, the longest continuous job expansion on record. Still, there are concerns about possible volatility in coming weeks as tariffs took effect between the U.S and China Friday on $34 billion in goods going into each country. The chance of additional tariffs affecting hundreds of billions of dollars more in imports could remain a check on stock market gains in the near future.

Those concerns seemed evident in the recent performance of a couple of stocks that some analysts believe could be more vulnerable to trade tension: Boeing Co. BA and Caterpillar Inc. CAT. Shares of both have fallen four consecutive weeks. Still, most of the market enjoyed a healthy week. The Dow Jones Industrial Average ($DJI) rose 0.8 percent, the S&P 500 (SPX) climbed 1.5 percent, and the Nasdaq (COMP) jumped 2.4 percent. 

Health care, info tech and consumer discretionary were among the leading sectors Friday. Some of the gains in health care reflected a big jump in biotech names. The Nasdaq Biotech Index (NBI) rose 3.72 percent Friday, helped partly by a 19.6 percent gain in shares of Biogen Inc. BIIB after the company announced successful results from an Alzheimer’s drug study. Over the last month, however, sector action has indicated more of a defensive tone among investors (see chart below). The leading sectors are utilities, staples, and real estate. One question is whether investors might start to feel more aggressive about putting money into so-called growth areas if earnings look strong.

Earnings aside, another thing to consider watching this week is the oil market. U.S. crude stocks are at their lowest levels in three years and crude oil prices are at three-and-a-half year highs after rallying sharply in the last month. If crude continues to strengthen, that could conceivably end up being a pressure point on profits for some companies, especially transports. Earnings calls could reveal whether energy prices are more of a factor.

Wage Gap?

Friday’s payrolls report for June helped drive the markets higher, but did leave some people scratching their heads. Sure, it was great to see jobs growth of 213,000 come in above Wall Street analysts’ expectations of 195,000, but monthly wage gains of just 0.2 percent when unemployment remains near two-decade lows seems like a conundrum. Typically, intense job growth like the type we’re seeing tends to create higher demand for workers, meaning they can get a little more leverage with wages. But the 2.7 percent year-over-year pay increase doesn’t show that happening. 

A lot of that might have something to do with the fact that at lower end of the scale, people are being replaced by machines. There are jobs, but there's a lot of lateral movement. When there’s competition from technology improvements and workers think they might get replaced by a robot, it could prevent them from demanding higher pay.

FIGURE 1: Cautious Approach:  As this one-month chart shows, investors seem to have taken a more cautious approach over the last month. Financials (candlestick) are struggling ahead of the big bank reporting season, while utilities (purple line) are the leading sector. Utilities often attract investors when people are concerned about possible market weakness. Data Source: S&P Dow Jones Indices.Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results. 

Commodity Corner

If the focus on tariffs and payrolls diverted your attention from the commodity market over the last few weeks, you may not be alone. Still, commodities are worth a look for what they might tell us about the broader economy—both here and abroad. Right now, a warning sign might be flashing. Notably, the price of copper, sometimes seen as a bellwether for world economic health, took a big hit over the last month. By midday Friday, the front-month copper futures contract at the Chicago Mercantile Exchange (CME) was down to $2.80 a pound, a major drop from near $3.30 a pound just about a month ago. Copper, used in many industrial applications, had been climbing steadily from its 2016 lows. It appeared to hit the brakes over the last month, though, as an index of Chinese demand has fallen four straight months, according to Bloomberg. Any sign of potential weakness in China’s economy is potentially one to watch, and analysts polled by Reuters expect Q2 GDP there to fall to 6.7 percent, from 6.8 percent in Q1. Copper futures fell 4.6 percent last week while the Shanghai Composite stock index fell 3.5 percent. 

What’s Next From the Fed?

There’s another Fed meeting scheduled for the end of this month, but many analysts expect that to be a placeholder without any significant action. No press conference is scheduled. Looking further ahead, CME Fed funds futures now put 80 percent odds on another rate hike by the Fed’s September meeting, which would be the third hike of the year. Chances for a fourth hike by the end of the year now stand at around 50 percent, futures prices indicate. That’s up from recent lows below 40 percent. One thing to consider keeping an eye on as the market continues to build in possible rate hikes is the yield curve, or the difference between 10-year and two-year yields. It recently fell to below 30 basis points, the weakest level since 2007. Though there’s a debate about whether falling yield curves signal recessions, some analysts say the lower yield on later-maturing debt could indicate weakness overseas, where interest rates remain low. Meanwhile, the Fed’s hiking cycle continues to push down the value of nearer-term debt. 

Summer Doldrums Ahead?

If you were looking forward to a break from volatility, Friday delivered. The VIX dropped more than 10 percent to below 13.5, quite a turnaround from the two-month highs above 18 seen in late June. It’s possible this drop reflects the U.S./China trade war potentially being built into the market after a period of adjustment that helped send VIX higher. It’s also possible we’re simply seeing a seasonal decline, which may have already been underway before that short spike in late June.

With the U.S. election approaching and the threat of more back-and-forth trade barbs, an extended vacation from volatility doesn’t seem likely, but you never know. One more doldrums-related note: Friday’s rally took place on what to date was the lowest volume full-day session of the year at the New York Stock Exchange (NYSE) and Nasdaq, with just 5.2 billion shares trading.

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