Light Goes From Green To Red As Weak European Data Puts Brakes On U.S. Rally

Renewed global growth fears might dim the rally lights a little Friday after yesterday’s Fed party.

A sharp rally Thursday that led stocks to five-month highs hit the brakes in pre-market action after European stocks fell sharply amid more soft data. Factory output in Europe slumped to its lowest level since 2013, helping send benchmark German 10-year yields fell below zero for the first time in more than two years. U.S. data might be strong, but it’s not getting matched overseas. That’s causing some worries now that might be reflected in Treasury note strength here.

The other factor that appears to be weighing on the market early Friday is Nike Inc NKE, which fell nearly 5% in pre-market trading after the company’s earnings data received a negative reaction.

Though NKE matched analysts’ revenue expectations and beat third-party consensus on earnings per share, the stock fell nearly 4% in post-market trading. The news media immediately focused on what some analysts called disappointing North American sales growth. Sales in the region did climb 7%, but just missed the Street’s estimates.

There were high expectations going into NKE earnings, especially after Foot Locker Inc. FL crushed Wall Street estimates for Q3, citing in part success with Nike products. One thing to keep in mind as NKE trades today is the other side of the world, namely China, where NKE saw its fastest quarterly growth of any region. Consider thinking about how those results might fit into the China picture, where we’ve seen some U.S. companies run into trouble recently while others continue to perform well. 

Speaking of China, U.S. negotiators head back across the Pacific next week to continue trade talks, but some media outlets are reporting that U.S. sanctions on two Chinese companies for allegedly helping North Korea’s nuclear program could be a new source of tension.

There was also some more bad news for Boeing Inc BA early Friday as Indonesia canceled an approximately $5 billion order for 49 of BA’s Max jets.

All these fresh concerns appear to be injecting a bit more volatility into the U.S. picture. The VIX—the market’s most closely watched fear indicator—shot back up to well over 14 early Friday from lows under 13 earlier this week. When VIX goes up, sometimes trading can get a little choppy. We’re also nearing the end of the quarter, a time when some fund managers traditionally start to do some position squaring. Sometimes that can cause volatility as well.

Fed-Led Rally Just Took A Day To Get Started

The Fed rally finally started Thursday; it just took a little time to come together. One night, actually. It also happened to leave one sector—Financials—almost completely behind.

After a sputtering finish Wednesday following the Fed’s dovish announcement, stocks got a wind at their back Thursday and finished with a flourish. The S&P 500 Index (SPX) rose more than 1% to finish at its highest level since early October. The Nasdaq (COMP) and Russell 2000 (RUT) outpaced the SPX. Even the Dow Jones Industrial Average ($DJI), still burdened by Boeing, finished much higher.

We’ll get to the “dogs of the Dow” in a minute. First, let’s check what’s carrying this rally. First, it’s hard to overlook the strong performance of Apple Inc AAPL over recent weeks. The stock got an analyst upgrade Thursday ahead of next Monday’s event where many analysts expect AAPL to announce some sort of streaming service. Shares of AAPL are knocking on the door of $200 again, up 37% from their January low.

AAPL’s shiny performance might have rubbed off on other stocks, and not just in Information Technology. It’s usually good for the market overall when AAPL is up, possibly because it’s so widely-held. It’s interesting to see what the upgrading analyst wrote about AAPL, stressing that some fears are overblown and that the company could continue to have steady growth. The analyst also said the price point issue—meaning some customers’ shock at seeing $1,000 phones—is fading. 

As many analysts have said, services is probably AAPL’s more exciting area now, because at some point phones will become commoditized. We aren’t quite there yet. At that point, arguably the importance of services would grow, but the problem with services is they’re a lower-margin product.

Semiconductors Leading Charge

Leaving AAPL for a moment, it’s also hard to overlook the semiconductors, a sector that got beaten down last year and saw many stocks get their values cut in half. Things have changed in a big way since then, with semis on a real tear lately amid hopes for a resolution on China tariffs and as solid U.S. economic data points to possible demand growth for electronic goods. 

Advanced Micro Devices, Inc. AMD is up nearly 27% since its March low posted less than two weeks ago. Nvidia Corporation NVDA and Micron Technology, Inc. MU are also making noise. Shares of all three companies rose more than 5% Thursday, with MU up nearly 10%. This is despite some supply issues in the industry that continue to weigh on pricing. Generally, however, stocks such as semis that have some China growth exposure seem to be doing well.

Home builders are also coming back as investors watch mortgage rates fall (see more below). Solid data from the Philadelphia Fed and a decent leading indicators report appeared to help the overall market Thursday as investors await existing home sales Friday. Consumer goods and consumer sentiment are both doing well, so the question is whether housing can join the party.

Financials Miss Out

We already discussed DJIA component BA not participating in Thursday’s surge, but the other companies left out of the party were mainly Financials. This was the only sector to fall on Thursday.

Some of the second-level banks took it on the chin Wednesday after the Fed meeting, and it was red pretty much across the board for banks on Thursday as investors pondered the prospect of an extended period of low rates. JPMorgan Chase & Co JPM, a DJIA component, was one of just a handful of DJIA stocks to fall Thursday. Goldman Sachs GS, another DJIA member, managed very slight gains, and Wells Fargo & Co WFC also fell.

Looking ahead from a technical perspective, it seems that 2865 might form an area of resistance in the SPX, just about 10 points above Thursday’s close. The SPX has had just a bit of trouble pushing through resistance lately, getting held up for a week near 2800 and then for a day or two around 2831. However, both those levels are well behind and the market is on a spectacular run.

See You Later: As they often do, the S&P 500 (candlestick) and the VIX (purple line) have gone their separate ways over the last year, as this chart shows. VIX ticked up early Friday, but remains below its historic average level of around 15 as the S&P 500 hits new five-month highs. Data Sources: S&P Dow Jones Indices, Cboe. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Borrowing a Page: It isn’t just U.S. borrowing costs going down after this week’s Fed meeting. The German bund yield fell sharply and is now trading around zero. Japanese and other European yields also dropped dramatically. While the U.S. 10-year yield now sits around 2.5%—just 10 basis points above where it was to start 2018—it still holds a heavy premium to those other interest rate products, so overseas investors might keep seeking yield here. If that happens, U.S. yields could potentially fall even lower. 

Today’s existing home sales report looks backward to February when borrowing costs were a bit higher, but maybe future housing reports might show some impact from lower rates. A possible beneficiary? The Financial Sector. Traditionally, Financials tend to do better when the housing market is strong and people are out there borrowing money and taking on loans. Another sector that could benefit, naturally, is home building. Thursday saw shares of home builder D.R. Horton Inc DHI rise more than 3%. 

Bond “Proxies” Appear to Like Fed News: S&P 500 Utility sector stocks are outpacing the S&P 500 Index (SPX) over the last month and were up sharply Thursday as it appears some investor money could be seeking higher yield in what analysts call “bond proxy” stocks. Utilities are one of those sectors, along with Consumer Staples and Real Estate, and all three did well Thursday after the Fed news. With Treasury yields falling about 70 basis points since last fall and the Fed no longer forecasting hikes in 2019, that could accelerated a trend that potentially favors these sectors, which tend to offer higher dividends. The S&P 500 dividend yield recently stood at 1.99%, up from 1.86% a year ago. That’s below 10-year note yields, but there’s a chance some investors might start to gravitate toward dividend yielders, considering the narrowing yield gap with Treasuries and the fact that traditionally, stocks have tended to outperform bonds. 

China Market Perks Up: It’s still early in 2019, but so far the year looks a lot brighter than 2018 did for stocks in China. So far this year, the Shanghai Composite is up more than 24% (through mid-week). That’s well ahead of the S&P 500’s (SPX) roughly 13% climb year-to-date. Some of the China strength might stem from hopes of a resolution to the U.S./China trade battle, but you also can’t rule out the possibility that China’s recent wave of government stimulus might be playing a role. The potentially worrisome thing is that various stimulus programs by the Beijing government already helped trigger a building boom over the last decade or two that’s contributed to rising debt across much of the country, according to media reports. It’s also left unfinished construction projects in many places and has helped send the government’s debt to gross domestic product (GDP) soaring.

This all might not end up mattering much, because after all people have been talking about a China “debt bubble” for years, and the economy keeps growing. There are still hundreds of millions of rural Chinese who could represent a future market for goods and services. That said, economic growth has trailed off over the last year as the government starts to clamp down on borrowing, making some economists wonder if the foundation for the market rally there might be a little shaky.

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