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Day After: Still Digesting Big Sell-Off After Rate Decision, Awaiting Nike Earnings

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Day After: Still Digesting Big Sell-Off After Rate Decision, Awaiting Nike Earnings
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(Thursday Market Open) A day after the Fed hiked rates and stocks fell to new lows for the year, the dominant theme seems to be rehashing what the Fed said and what it might mean for the coming months.

There’s a sense that even though the Fed stepped back from three hikes in 2019 and now only sees two, it didn’t give investors the dovish tone they might have been hoping to hear. If people had been waiting for the Fed to spell out specifically that this was a “one and done” and it planned to pause, they didn’t get that message yesterday. That could be one reason why stocks took a beating after the news hit.

For the Fed, however, yesterday’s rate decision might have been a no-win situation. 

If it didn’t raise rates, the market might have dropped due to worries about possible unknown economic weaknesses. A rate hike, on the other hand, would risk getting people concerned about rising borrowing costs in an economy that seems to be slowing a little.

Faced with no really great options, the Fed chose to raise rates by 25 basis points yesterday. The sell-off that followed sent the S&P 500 (SPX) down to new lows for the year and off more than 14% from its 2018 closing high posted less than three months ago. While most investors had anticipated a hike, peripheral factors like Powell’s tone in the press conference and the Fed’s predictions of slowing economic growth probably played a bigger role in the sell-off than the hike itself.

Stocks showed a little recovery in the pre-market hours despite weakness in Asia and Europe, but it didn’t look like any major rally brewing. There was some earnings news since the closing bell, with both Walgreens Boots Alliance (NASDAQ: WBA) and Accenture Plc (NYSE: ACN) beating Wall Street analysts’ earnings per share estimates and issuing solid outlooks.

Nike Inc. (NYSE: NKE) laces up for its earnings after the close. The last time NKE reported, it beat on both the top and bottom-line. Continued double-digit growth in international sales and Nike direct-to-consumer, combined with sales momentum in North America, were some of the drivers, management said at the time.

Bear Market Still Not Here, But Many Stocks Already There

The SPX isn’t officially in a bear market yet. That would require it to fall another six percentage points. However, as media headlines pointed out late Wednesday, about 60% of SPX stocks are already in bear market territory, meaning they’ve dropped 20% or more from their highs. Energy, materials, and financials all are in bear markets, and almost every other sector has suffered a 10% correction.

It’s hard to blame the Fed for the market’s flop late Wednesday, because arguably if the Fed hadn’t moved raised rates, it might have led to a bigger disaster. People would have likely been scratching their heads, wondering what Fed officials know about the economy that others don’t.

The Fed did lower its path for the next year, which would imply just two rate hikes and puts the target range between 2.75% and 3%. It wasn’t necessarily as dovish as some investors might have wanted (some were predicting just one hike next year), but it’s hard to know how much more dovish the Fed could have been. It had previously forecast three hikes, and if the “dot plot” suddenly showed just one, it could have triggered the same market worries as if the Fed didn’t hike. 

As Fed Chairman Jerome Powell said in his press conference after the decision, the Fed can be patient here and watch the data. The dot plot isn’t set in stone, and isn’t even necessarily a forecast. It’s just what Fed officials see based on the economy today, and that can change in the months ahead. In other words, if data and earnings growth weaken, the Fed’s next dot plot might come down to where some investors were thinking. It won’t come out until March, however, so there’s a long wait.

Remember, too, that the Fed decision was story “1-A” yesterday. It still might be difficult to rally significantly, because the tariff situation continues to hang over the market. As long as that exists, it seems like it’s difficult for some investors to really get super excited about stocks right now. No one knows what path the trade negotiations with China could take over the next two months before the president’s 90-day deadline, which roughly corresponds with March 1. Until there’s more clarity, the market could continue to be under a cloud of uncertainty. Arguably, it’s still all about tariffs, and that might remain the primary story. 

If there’s a story “1-B” brewing, consider the fact that there’s still no deal on Brexit with the new year approaching. This could start gaining more significance as the late March deadline approaches and the possibility of a “no deal Brexit” starts to loom. A lot of economists are worried about how the British economy might respond, and about potential impacts on the entire European economy. It doesn’t sound like a recipe for bulls.

Stocks Get Slammed To New 2018 Lows After Announcement

Stocks fell to new lows for the year soon after the decision, retreating from strong early gains. By an hour after the announcement, the S&P 500 Index (SPX) was down to just below 2500, compared with its 2940 intraday high for 2018 less than three months ago (see chart). The SPX managed to hold ground just above 2500 by the close. Some analysts see a lot more room to the downside, with little technical support between here and 2400. A drop down to that level would put the SPX within a whisker of bear territory.

Looking at the sell-off a day later, it seems like maybe some investors might have been focusing less on the rate hike—which had been widely expected—and perhaps more on the Fed’s easing economic outlook. The Fed now sees 3% U.S. gross domestic product (GDP) growth this year, down from 3.1% previously. It expects 2.3% GDP growth next year, down from the previous 2.5%. Whether many investors had anticipated this ahead of time is debatable, but the market never seems to like a surprise.

Seeing the Fed lower its growth projections even as it raises rates and continues to trim its balance sheet might have increased some of the worries flying around about the economy’s vitality. Some of the language Powell used in his press conference about how 2018 was a year with a rising growth trajectory but 2019 might be one of moderating growth could have added to fears that the best growth might be behind us. 

Not to say that’s necessarily the case, but the Fed’s forecast for GDP does seem to indicate that. A few years ago, economists worried about the slow post-recession growth that saw GDP rise just around 2% a year. After what appears to be much better growth in 2018, with a 3% number for the first time in more than a decade, it’s a bit disappointing to see the Fed put a 2 as the lead number for 2019. Especially a number below 2.5%. That isn’t too far off of where some economists had been thinking, but seeing the Fed there, too, puts kind of an official stamp on the bearish growth outlook.

Looking around, investors might be curious which sectors could benefit or lose from the Fed’s rate hike. It’s probably bearish for dividend-paying ones like utilities and health care, but potentially positive for financials. Some analysts, however, took a different approach, saying the drop in 10-year Treasury yields following the hike might send a message that the market anticipates more economic pain, putting staples and utilities conceivably in better position.

Narrowing Curve Back in Focus

Worries about higher interest rates possibly choking the economy seemed to tick up after the rate hike, and one indicator of that was arguably the yield curve. The gap between two-year and 10-year U.S. Treasury yields fell below 10 basis points overnight, a new low for the year and down from 16 earlier this week. If the curve goes inverted, that’s historically been associated with recessions—though cause and effect get debated. 

In what looked like a sign of these troubled market times, the 10-year yield fell below its long-term technical support level of 2.8% to trade at 2.78% late Wednesday. It was the first time under 2.8% since...wait for it...May 30.

spx-tnx-fed-meeting-12-18.jpg

Figure 1: Stocks, Ten-year Treasury Yield Fall After Hike. Wednesday's rate hike seemed to pressure stock indices such as the S&P 500 (SPX - candlestick chart). But a seemingly dovish tone for 2019 helped send the yield on the 10-year (TNX - purple line) down to 2.78%  Data Source: S&P Dow Jones Indices, Cboe Global Markets. Chart 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.

Meeting Over, But Volatility Persists Ahead Of Quadruple Witching: Even with the Fed meeting out of the way and the Christmas week ahead, there’s not much sign of anyone relaxing on Wall Street. The VIX—the best-known market “fear gauge”—stayed above 25 late Wednesday after the Fed decision, near its highs from October when stocks first fell out of bed. That could indicate that this remains a very nervous market, possibly prone to quick moves. Things have a chance to get even more volatile thanks to quadruple witching on Friday, which is the simultaneous expiry of stock index futures, stock index options, stock options and single stock futures. If you’re a long-term investor, you may want to consider making your trades in increments at this point, and not risk any big moves in what could be a quick-moving market. The same arguably applies to anyone trying to trade this market. These aren’t calm times.

Red Flags to Consider: Here’s an interesting takeaway that investors might want to keep in mind for future reference. Early Tuesday, stock futures pointed to a higher open, and all the major indices rallied first thing. However, people who closely watched certain signals might have had an inkling that things weren’t necessarily so positive. That’s because what are sometimes known as the “three horsemen of risk”—VIX, Treasuries and gold—all were either higher or holding steady. This could have been an indication that stocks stood on shaky ground.

Sure enough, the market ended up giving back most of its gains toward the final hour, in part because investors seemed more prone to embrace risk-off assets like Treasuries and gold, and also because volatility (as measured by VIX) remained elevated. If these risk-off signals had been lower while stocks were climbing, it might have been a more bullish signal that the stock rally could continue. The fact that they were all up even as stocks rallied sent a signal that the normal relationships were off, and stocks might not hold their gains. So remember, if stocks are higher on a given day, you might want to give VIX and Treasuries a look. If they’re up too, it could mean the guy on the beach might be waving that red flag telling you not all is clear. Even if you don’t normally trade VIX or Treasuries, it’s arguably important to understand what signals they’re sending. When relationships are off, it can sometimes be an opportunity, but also could represent a warning sign.

Same Sector Parent, But Not Twins: The energy sector continues to get bashed just about every day as worries about the economy and trade with China hover over the market. However, not all energy stocks are the same, and investors might want to keep their differences in mind as they track the market. Two of the largest ones—Chevron Corporation (NYSE: CVX) and Exxon Mobil Corporation (NYSE: XOM)—share some things in common, for instance, but not everything. CVX is more of a straight crude stock—meaning its business is more tied to the price of crude—than XOM, which has a big plastics and natural gas business, too. So investors who think crude might rebound might be more likely to watch CVX for clues, while those who think natural gas prices might drop might want to consider watching XOM. Not that either of these scenarios is necessarily going to happen, but it’s arguably a good reminder that every sector has its variances, and that savvy investors can get to know those differences and use them to get a read on the market.

Posted-In: Nike earnings Rate Hikes Stock Market Update TDAmeritradeNews Retail Sales Federal Reserve Markets

 

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