Tropical Storms And Trade Storms: Oil, Dollar Rise On Weekend Tumult

After a long weekend of cookouts and college football, investors turn their attention back to the market today. Trade concerns that haunted the Street late last week haven’t necessarily gone away, but stocks have remained very close to all-time highs amid continued U.S. economic strength.

Meanwhile, Tropical Storm Gordon has been picking up steam as it heads north through the Gulf of Mexico. As some offshore oil rigs suspend operations, WTI crude raced past $70 a barrel to above $71. This may be a story worth watching as it unfolds this week. Weather-related supply disruptions can sometimes have far-reaching economic effects.   

Also, the U.S. Dollar Index ($DXY) is up a bit this morning on weakness in several major currencies, perhaps most notably the Canadian dollar, which fell on comments from the President concerning the future of NAFTA and its potential replacement. Recall last week the U.S. and Mexico struck a trade deal, without Canada. Talks with Canada broke down without any concrete agreement. According to office of the U.S. Trade Representative, the U.S. and Canada exchanged more than $670 billion in 2017.

Last Week Roundup

Though the end of last week was a little shaky, August closed out with healthy gains for all of the major indices. The S&P 500 (SPX) rose 3 percent, while the Nasdaq (COMP) climbed 5.7 percent and the Dow Jones Industrial Average ($DJI) gained 2.2 percent. For the $DJI and SPX, it was the best August since 2014, and both the COMP and SPX achieved all-time peaks during the month. It was also the fifth-straight positive month for the SPX.

August markets got help in part from a robust earnings season that saw average earnings per share rise 25 percent for S&P 500 companies, the best quarter since Q3 2010, according to FactSet. The average 10.1 percent revenue growth was the best since Q3 2011.

COMP led the gains as stocks like Apple Inc. AAPL and Amazon.com, Inc. AMZN climbed sharply during the month. Small-cap stocks also had a big August, with the Russell 2000 (RUT) posting record highs last week (See Fig. 1 below).

It’s Payrolls Time Again

Arguably, all roads this week lead to Friday’s monthly payrolls report. If you think back to last month, the headline number of 157,000 jobs created in July came in a bit below Wall Street analysts’ average estimate, but the stats looked pretty good otherwise as the government raised payroll growth for the previous two months and said average hourly earnings growth was 2.7 percent over the last year, the same as in June. Unemployment of 3.9 percent remained near 20-year lows.

The wages number might be the one to watch again Friday as many investors remain on tenterhooks due to worries that a big jump in pay might force companies to raise prices. Last week’s Personal Consumption Expenditures (PCE) prices index showed annual inflation at 2.3 percent, the highest level in more than six years.

We’ll preview estimates for the payrolls report later this week. For Tuesday, however, focus might continue to be on trade. Last week, Bloomberg reported that President Trump might slap new tariffs as soon as today on $200 billion in Chinese goods. That appeared to be a factor in the market’s slight retreat Thursday and Friday from big gains posted earlier in the week, so consider staying on your toes for possible updates.

An Open Question: What’s the Next Catalyst?

With markets so strong and earnings season now well in the rear-view mirror, there’s a lot of debate over what might be the next catalyst for another leg higher. While there’s no way to predict which way the market might go, these next few weeks could see more volatile trading as the market reacts to headline news developments, including weakness in emerging markets and trade spats. These worries could roil the markets over the next two weeks, so long-term investors might want to consider not paying too much attention to every up or down move and stick to their long-term plans.

One school of thought suggests that it’s in the best interests of both the U.S. and China to get a trade deal done, and if one is actually agreed on it could give the market a boost. However, we’ll just have to wait and see, and there could be turbulence in the meantime.

Seasonality might be another thing to keep in mind. Though history isn’t guaranteed to repeat, the SPX has been down more than up in September during its history dating back to the 1950s. Also, September is pretty dry from an earnings standpoint, so investors won’t necessarily have strong earnings to fall back on in the case of negative geopolitical news.

Could Overseas Weakness Start Seeping In?

The psychology around Wall Street appears to remain pretty positive, for the most part, and it doesn’t seem like any dramatic change is in the air. However, overseas developments might provide a brake on U.S. sentiment. Over in the U.K. the FTSE index is at a four-month low and the next developments with Brexit might continue to dog European markets. In China, the Shanghai Composite entered this week on a losing streak and is down sharply for the year.

It’s sometimes easy to forget troubles across the ocean when the U.S. economy and markets are rolling along, but the U.S. economy doesn’t exist in a vacuum. The Fed meets later this month, and one thing it might have to take into account is how much higher U.S. rates can go while rates overseas remain at levels not far from where they were during the 2008-09 financial crisis.

With the Fed’s meeting still several weeks away, CME Group futures put better than 98 percent odds on another 25-basis point rate hike. Chances of an additional 2018 hike, which would be the fourth of the year, stand at around 70 percent.

FIGURE 1: SMALL PACKAGES: The Russell 2000 small-cap index (RUT) posted sharp gains in August to reach record highs after a sluggish start to the month. The Nasdaq (purple line) also put in a strong August, bolstered by strength in some of the so-called “FAANG” stocks, including Apple (AAPL) and Amazon (AMZN). Data Source: FTSE Russell, Nasdaq. Chart source: The thinkorswim^® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Brakes or Gas?

There’s a bit of a debate going on about the Fed’s policy next year. Some analysts say the Fed might be inclined to step back in early 2019 and check the surroundings before extending its current hiking cycle. This school of thought suggests that after the likelihood of two more hikes before the end of this year—which would bring Federal Funds rate to a range of between 2.25 and 2.5 percent (from the current 1.75 to 2 percent)—the Fed might want to get a better sense of whether higher rates are having any impact on economic growth and on the yield curve before making another move. As some Fed officials have said, they’re leery of raising rates too quickly in a way that might slow the economy. Also, continued weakness in overseas bond yields might mean an even wider gap in rates that could push the dollar higher and possibly hurt U.S. companies that export.

On the other side of the coin, some analysts believe the Fed might be inclined to move even more quickly. If inflation takes off and starts coming in above analysts’ estimates, the Fed might find itself behind the curve and have to tighten at a faster pace than previously expected. In all, it’s a bit of a confusing picture and we can only wait and watch.

Jewelry and Clothes But Not a House

Last week’s consumer confidence numbers and recent retail earnings seemed to indicate strength, with the University of Michigan’s final August sentiment figure coming in slightly above expectations at 96.2 and up from the previous 95.3. Then there was Lululemon Athletica Inc. LULU big earnings beat and similar exuberant results from a couple of luxury retailers like Tiffany’s & Co. TIF. The places where consumers don’t seem to be showing up are the auto dealer and the real estate office. Both of the housing sector reports (weekly mortgage applications and pending home sales) fell last week, and July auto sales released a few weeks ago were disappointing for most of the big automakers. Investors trying to get a handle on what seems to be a divergence might want to pay attention to tomorrow’s August auto sales figures and keep watching housing data. Typically a strong jobs market like the one we’re in tends to be solid for housing and autos, but that just isn’t the case at the moment.

Taking a Flight?

It might cost a bit more, and not for the ticket. United Continental Holdings Inc. UAL just announced it’s raising the price of a passenger’s first checked bag to $30 from $25, explaining that this will help the airline “continue investing in the overall customer experience in today’s marketplace.” This followed a similar recent move by JetBlue Airways Corporation JBLU and some other airlines. While travelers might bemoan higher fees, the news isn’t necessarily bad from an investor angle. We’ve talked about how all the demand in retail is helping consumer discretionary stocks, and airlines also benefit. A strong economy can mean more people flying for business and pleasure, helping bottom lines at airlines and, possibly, returns for investors with positions in airline stocks. In fact, with airlines under pressure to keep ticket prices low, the addition over the last decade of baggage fees, Internet fees, and other costs that might seem “nickel and dime” for the average passenger have arguably been a big boost for the airline sector, at least from a stock market perspective.

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