Wall Street Appears Set For A Pause After Recent Gains

Upbeat U.S. stock market sentiment on Wednesday appears to be ebbing today as earnings season rolls on, tensions over trade seem to be weighing and investors are perhaps consolidating yesterday’s gains.

In earnings news, Bank of New York Mellon Corp. BK reported earnings before the open today that were largely in line with expectations, but shares fell this morning. The bank’s shares had risen when other big bank earnings were released. Earnings were solid, but not necessarily stellar. Shares of American Express Company AXP and eBay Inc. EBAY were also under pressure after earnings disappointments.

Financials and Industrials Jump

The financials sector, up 1.53 percent, and the industrials sector, up 1.13 percent, were shining spots of green Wednesday amid all the other S&P 500 (SPX) sectors, which were either lower or essentially flat .

Financials got a boost after Morgan Stanley MS became the latest big bank to notch an earnings beat as the season is off to a mostly positive start. MS easily exceeded Wall Street analysts’ expectations. Shares rose more than 2.8 percent.

The results capped a solid quarter for the big banks. Results from the financial sector can help set the tone for market sentiment during earnings season. Entering bank earnings season, the financial sector had been lagging the SPX so far in 2018. The major story apparently weighing on the big banks has been the flattening yield curve.

Meanwhile, the industrials sector also shined Wednesday, helped by earnings results from transportation companies CSX Corp. CSX and United Continental Holdings Inc. UAL. The airline’s shares rose nearly 8.8 percent while shares of rail company CSX jumped more than 7 percent after both reported stronger-than-expected earnings.

Dollar Strength

The dollar has shown significant strength in recent days, not only against other major currencies such as the Brexit-weak British pound, which has fallen over 10 percent since April, but also against gold, another traditional store of value. China’s currency, too, has fallen over 4 percent over the past month (more on that below). The U.S. Dollar Index ($DXY) jumped above the mid-95 level today, eclipsing a mark from April, to its highest level since July of last year (see figure 1 below). As the U.S. economy hums along, as has the pace of interest rate hikes by the Fed, dollar-denominated assets have seen strength.

Looking East, Seeing Weakness

Speaking of weakness vs. the dollar, China’s yuan has fallen more than 4 percent over the past month, and last night fell to its lowest level in a year as its central bank, the People’s Bank of China (PBOC) weakened its currency fix beyond 6.7 to the dollar. The PBOC looks to be easing its currency in response to signs of economic weakness. Though the Chinese government reported earlier this week that its economy grew at an annual rate of 6.7 percent percentover the past few months, other data show weakening infrastructure investment and a possible uptick in loan defaults, according to a New York Times report.

China’s stock market has shown weakness as well, with the benchmark Shanghai Composite Index down nearly 5 percent over the past month, and down over 14 percent over the past 12 months. A strained trading relationship with the U.S. has certainly not helped the world’s largest export economy. Weakening its currency might help China counter the effect of tariffs assessed on its goods by the U.S.

While it’s too early to suggest long-term weakness is in the offing, or that weakness might spread throughout the Asia-Pacific region—seasoned investors will recall the “Asian Contagion" of 1997-98 that hit the region hard and eventually spread across the globe—it might be worth keeping an eye on China.   

FIGURE 1: DOLLAR AT 1-YEAR HIGH. The U.S. Dollar Index ($DXY) rose to a level not seen since last July on weakness in European currencies, especially the British pound, which has fallen 10 percent since April. Currencies such as the Australian dollar and Canadian dollar have also fallen along with weakness in commodities markets. Data source: ICE. Chart Source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Tariff Worries, Economic Expansion

The latest Federal Reserve beige book was a bit of a mixed bag. Manufacturers in all Fed districts expressed concern about tariffs and in many districts attributed higher prices and supply disruptions to new trade policies. And many districts said that the inability to find workers in a tight labor market constrained growth. Still, employment continued to rise at a modest to moderate pace in most districts, and overall economic activity continued to expand across the United States. Prices were on the rise in all districts, with gains coming in at a modest to moderate average pace. The report could give ammunition to both hawks and doves. Moderately rising prices could argue for keeping the status quo view that interest rate hikes might continue in a slow and steady fashion. But trade- and labor-related constraints to growth could argue for spacing out rate raises even more.

Housing Starts Stumble

The tight labor market may be pressuring the housing market to the downside. The latest housing starts data, from June, showed a decline to a seasonally adjusted annual rate of 1.173 million units, well under the 1.318 million units expected by economists, according to a Briefing.com consensus. “The key takeaway from the report is that it reflects weakness at a time when there should be strength,” according to Briefing.com. “The assumption embedded in the weak starts figure is that it likely reflects the difficulty builders are having finding labor, as well as the constraints they are facing with higher land, labor and material costs.”

Technically Speaking

On Wednesday, the S&P 500 pushed closer to its all-time high from January of just under 2873. “A new high would confirm that this bull market remains alive and well and is only a little more than one month away from becoming the longest since WWII,” according to a Wednesday note from investment research firm CFRA. For those following technicals, the S&P 500 has broken through resistance in the 2789-2802 range, CFRA said. With a close above 2815, the index on Wednesday was in what the firm calls a “minor zone of resistance” between 2813 and 2839. From there, CFRA sees greater resistance at the January high.

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