Wall Street Olympics: Watching To See If Stocks Can Recover Even As Yields Rise

A weekend of snowboarding, skating, and skiing in South Korea is over, and a new trading week dawns on Wall Street. European and many Asian stocks moved solidly higher early Monday, lending a positive spin after last week’s crushing worldwide losses. U.S. pre-market trading pointed toward the chance of more strength following Friday’s late rally.

That’s not to say everything is ship-shape, though. Over in the interest rate complex, yields rose again early Monday, with the 10-year climbing to a new four-year peak of 2.9% before retreating just a bit. The jury is still out on whether stocks can resume rallying as borrowing costs continue to track higher.

It’s tempting to think of the new week as kind of a re-start to the year. We’ve arguably had more drama in the last 40 days than in all of 2017, with stocks rocketing about 7% in January before taking less than two weeks to plummet 9% from the all-time high reached Jan. 26. Some investors who anxiously watched their portfolios take a beating last week might feel like wiping their mental slate clean and trying to forget about those two 1,000-point stumbles in the Dow Jones Industrial Average ($DJI), but it would be a mistake to get complacent just because the old week ended with gains.

As an investor, now isn’t the time to go all in, even if you’re convinced the worst is over. The markets trembled last week, and there could still be some after-shocks. Volatility is down pretty sharply this morning, with the VIX under 27. Historically, however, that’s still pretty high and means more choppiness could possibly be ahead. Long-term investors should probably consider not watching every tick in the market unless they have nerves of steel.

If you’re looking for fundamentally positive developments that could potentially help shake stocks out of their stupor, consider casting an eye toward Washington, D.C., of all places. The president plans to introduce his infrastructure plan today, and in the past, talk of infrastructure spending has sometimes boosted certain sectors, including industrials and materials. Even info tech might benefit from increased infrastructure spending, because so much technology is involved in construction and building now.

On a technical note, perhaps a ray of hope came through when the S&P 500 (SPX) fell below its 200-day moving average Friday before rebounding to close well above that technical marker. Chart watchers say historically, a turn-around like that can sometimes change the technical perspective moving forward. Still, in this volatile environment, it’s probably a good idea to be skeptical about blindly trusting any historical patterns.

A lot of selling pressure showed up even in the last few minutes of trade Friday as the market executed that turn-around, taking some of the shine off what had been looking like a really positive finish. That could mean sellers are still out there ready to exit positions on rallies as the week begins. As we’ve said, volatility could easily take another two to three weeks to work through the system, if history is any guide.

Data starts to pick up this week after being pretty quiet since the now infamous January non-farm payrolls data that arguably helped set off Wall Street’s stumble with that 2.9% year-over-year wage growth. Wednesday brings the consumer price index (CPI) for January, and producer prices are due Thursday. If inflation is actually starting to rekindle, perhaps those reports might show it. Retail sales for January are due Wednesday, and also might be watched more closely than usual. Remember, though, that January was a hot month for stocks, so even if retail sales posted big gains then, consumers might be feeling different these days with the market playing defense and portfolios feeling lighter.

Median forecasts are for consumer price inflation to slow a little to 1.9% year-over-year in January, mainly due to the base effect of a high reading in January 2017, while the core measure is seen ticking down to 1.7%, Reuters reported.

Earnings season is on the wane but far from over. A bunch of major companies report this week, including Deere and Company DE and The Coca-Cola Co KO on Friday. Investors might want to listen to what executives say on these calls to hear if the stock market plunge had any impact on consumer demand or company financial plans. The other big question to focus on, considering the inflationary fears circulating all around, is whether executives see any pricing pressure due to higher wages.

Commodities generally took a beating last week, and that’s pretty evident in the crude oil market. Crude has gotten more in sync with stocks over the last week, falling 9% as Wall Street got trounced to a similar tune. Oil prices rose 2% to back over $60 a barrel by Monday morning amid the strength in Asian and European stock markets.

FIGURE 1: NO SMALL FEAT. While no major index performed very well last week, to say the least, the Russell 2000 (candlestick) index of small-cap stocks did come out a little better than the S&P 500 (SPX, purple line), from a percentage loss basis. Small caps, like many other indices, had been at record highs before the collapse last week. Data source: FTSE Russell, Standard & Poor’s. Chart source: The thinkorswim^® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Over There

Across the Atlantic, selling in both stocks and bonds has been nearly as frantic as here in the U.S. European stocks had their worst week in two years and are down more than 5% so far in 2018. Rising rates seem to concern many European investors, with the German bund yield climbing to 0.8% for the first time since 2015. European Central Bank officials appeared to try to calm things down late last week, saying policy normalization will be a “long, complex” process, according to Bloomberg News.

Fears had arisen that the ECB might decide to move more quickly than previously expected on its wrap-up of quantitative easing. ECB President Mario Draghi told lawmakers last week that policy will evolve in a data-dependent and time-consistent manner, claiming it’s too soon yet to claim victory in inflation, Bloomberg reported. Asset purchases are currently scheduled to run at a monthly pace of 30 billion euros ($37 billion) through September, and the ECB has pledged to keep interest rates at their current record-low levels until “well past” the end of bond-buying.

Executive Suite

U.S. company leaders don’t seem too shaken by the fireworks on Wall Street so far. A number of CEOs expressed their faith in the economy last week and added that they don’t expect the market downturn to have a big impact on customer demand. Investors might want to consider listening to what executives say at times like these, because they tend to have front-row seats to economic activity and consumer sentiment. Some of the companies expressing confidence to the media Friday included Alibaba Group Holding Inc. BABA and AT&T Inc. T. AT&T Chairman and CEO Randall Stephenson told CNBC he had dinner with other CEOs this week and they all told him “business is as good as it’s been in a long time.”

Deep in Debt

A lot of moving pieces help explain why yields might be rising in the interest rate complex. People have talked about the new spending in the budget just passed by Congress and signed by President Trump, which could add as much as $1.7 trillion to the U.S. debt over the next 10 years, according to Committee For a Responsible Budget. When additional debt floods the market, it often means buyers demanding higher rates. In addition, the Fed is reducing its balance sheet, which means less reinvestment by the Fed in maturing debt, leading to additional paper entering the market.

The $1.5 trillion tax cut passed by Congress last year could also raise deficits, studies show, and U.S. debt is higher than at any point since World War II. Rising yields in Europe might be playing into U.S. bond weakness. For many months and even years, very low European yields meant investors might have seen U.S. yields as attractive. European yields remain low, but not as low as they used to be, as evidenced by the German bund yield climb. That conceivably pulls some investments in fixed income to places outside the U.S.