For a PDF version of the below commentary please click here weekly-letter-11-21-2016
Commentary quick take:
- Major developments:
- Markets continue to adjust to President-Elect Trump
- Fed Chair Yellen testified before Congress
- Odds of a rate hike in December now at 100%
- Politics
- Trump back pedaled on some of his policies
- Hard time filling out his administration
- Earnings season:
- 95 percent complete for S&P 500
- Blended earnings on the S&P 500 stands at 3 percent
- US Fed:
- Chair Yellen’s testimony signaled a rate hike in December
- Reiterated slow and gradual hikes going forward
- Markets pricing in four hikes in 2017
- Europe:
- Italian banks are once again under pressure
- ECB maintains cautious outlook
- Brexit and Trump uncertainty weighing
- Technical market view:
- Trump rally moved into second week
- VIX pushed lower
- S&P 500 and NASDAQ have moved into an area of significant resistance
- Hybrid investments strategy update:
- Purchased PGHY
- Bounce back in several core stock positions
- Wal-Mart earnings moved the stock
- This week for the markets:
- Thanksgiving shortened trading week
- Trump policies will come into more focus
- Black Friday holiday shopping
- Interesting Facts: Thanksgiving
Major theme of the markets last week: Ready for rate blast off?
The major theme of the financial markets last week was Fed Chair Janet Yellen’s testimony before Congress and the revelation that the Fed is now almost certainly going to be raising rates at the December meeting. With the fear of appearing too political by raising rates at the November meeting now behind the Fed, Chair Yellen gave prepared remarks about the current state of the US economy, in which she outlined pretty clearly that baring some anomaly in the data that comes out over the next three weeks, the Fed will be increasing rates at the December meeting. In fact, the Fed watch numbers currently have the odds of a rate hike at 100 percent. With rates moving higher and President Trump filling in the blanks in his administration in terms of personnel, we could be in for an exciting time in the financial markets, both on fixed income and equity investments. If the Fed manages to raise rates in December it will be the only hike it pulled off during 2016. Going into the year, you may remember that many Fed officials were calling for as many as four hikes throughout 2016. This, interestingly enough, is the number of hikes the markets are now pricing in for 2017, despite all of the uncertainty about the situation in Washington DC. The year 2017 is setting up to be a very interesting year, both here in the US and around the world.
US news impacting the financial markets:
Federal Reserve Chair Janet Yellen headlined the financial news last week as she testified before Congress on Thursday. She was speaking before the Joint Economic Committee and provided her prepared remarks, followed by several hours of questions and answers from both sides of the political aisle. The following short paragraph in her prepared remarks is what Wall Street really latched on to:
“At our meeting earlier this month, the Committee judged that the case for an increase in the target range had continued to strengthen and that such an increase could well become appropriate relatively soon if incoming data provide some further evidence of continued progress toward the Committee’s objectives. This judgment recognized that progress in the labor market has continued and that economic activity has picked up from the modest pace seen in the first half of this year. And inflation, while still below the Committee’s 2 percent objective, has increased somewhat since earlier this year. Furthermore, the Committee judged that near-term risks to the outlook were roughly balanced.”
Shortly after she said the above paragraph, the odds of a rate hike at the December meeting, which is only a few short weeks away, went to 100 percent. The odds of rates moving higher at meetings in 2017 also increased. Four rate hikes during 2017 is likely. With near certainty of a rate hike in December, the bond market in the US adjusted lower and losses that started with the surprise Trump victory seemed to carry over a second week last week. Corporate earnings continued to impact the overall markets last week as we continue to see a strong third quarter for corporate America.
Companies that reported earnings last week focused on the retail US consumer as we are now very close to the end of the third quarter reporting period and retailers are always some of the last companies to report earnings. Below is a table of the well-known companies that released earnings last week, with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:
| Abercrombie & Fitch |
-89% |
Famous Dave’s of America |
-90% |
Ross Stores |
11% |
| Agilent Technologies |
13% |
Foot Locker |
2% |
Salesforce.com |
0% |
| Best Buy |
32% |
Gap |
0% |
Staples |
0% |
| Buckle |
-6% |
Gordmans Stores |
pushed |
Stein Mart |
-50% |
| Cisco Systems |
2% |
Home Depot |
1% |
Target |
25% |
| Dick’s Sporting Goods |
14% |
J M Smucker |
6% |
TJX Companies |
5% |
| Diebold |
17% |
Lowe’s |
-8% |
Wal Mart Stores |
2% |
One theme last week in the earnings was that the big box and discount retailers performed well during the third quarter. Ross stores turned in the top performance of the group last week, beating expectations by 11 percent, while rival TJ Maxx beat expectations by only 5 percent. Wal-Mart and Target were both closely watched, with Target seeing a higher upside surprise than Wal-Mart, but both turned in solid quarters. Both companies forecast strong sales around the holiday season, which officially kicks off on Friday morning across the US with Black Friday sales. Higher-end clothing retailers Abercrombie & Fitch and Buckle both struggled during the quarter as fall and the first part of winter was warmer than expected across much of the US, leading to less early season shopping for winter clothing. With such poor performance in the third quarter, the companies will likely see better than anticipated sales in the fourth quarter as consumers finally start to feel the colder temperatures and shift their wardrobes to winter attire. The home improvement sector’s two main companies, Home Depot and Lowe’s, both reported earnings last week with Home Depot earning slightly more than expected, while Lowe’s fell short. Both companies blamed the lack of sales on the weather in the US, much like the higher-end retail clothing companies.
According to Factset Research, we have seen 477 (95 percent) of the S&P 500 companies release their results for the third quarter of 2016. Of the 477 that have released, 72 percent have beaten earnings expectations, while 7 percent have met expectations and 21 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 55 percent of the companies have beaten estimates, while 45 percent have fallen short. Both the revenue figures as well as the earnings per share figures stayed relatively unchanged, when compared to the levels seen two weeks ago. The earnings figures above are within 1 percent of the 5-year average level, while the revenue figures are equal to the 5-year average level that we have seen on the S&P 500. The overall blended earnings growth rate that has been seen so far for the S&P 500 is 3.0 percent, which is significantly better than the anticipated -2.2 percent that was expected going into the quarter. With only 5 percent of the companies in the S&P 500 needing to report earnings, it is becoming increasingly unlikely that the above mentioned figures will change by a material amount between now and the end of the reporting season.
With Thanksgiving occurring on Thursday this week, it is not surprising to see a very low number of companies reporting earnings this week as we move into the final three weeks of third quarter earnings season. The table of well-known companies below shows the companies that have the greatest potential to move the markets highlighted in green:
| Barnes & Noble |
DSW |
Jack In The Box |
| Campbell Soup |
GameStop |
Palo Alto Networks |
| Deere & Co |
Hewlett Packard Enterprise |
Seadrill |
| Dollar Tree |
Hormel Foods |
Tyson Foods |
Consumer facing retail companies once again make up the majority of companies that are reporting earnings this week. Deere & Co is one company that will be closely watched by Wall Street this week as its products are used in many different businesses and slowdowns in a variety of sectors can be seen early on in the company’s revenue figures. Three of the major food producers in the country (Tyson, Hormel and Campbell’s) report earnings this week with fairly lofty expectations for the third quarter, thanks in large part to declining commodities prices, which were mostly not passed along to the end consumer. The final news last week here in the US that impacted the financial markets was political as President-Elect trump continues to fill out his cabinet.
Keeping with the political outsider theme that he ran with for much of his campaign, President-Elect Trump moved forward last week with filling a few key spots in his administration. He appointed Jeff Sessions as Attorney General. He picked Lt. General Michael Flynn as his national security adviser; a controversial pick as he was dismissed by President Obama. In former Secretary of State Colin Powell’s words, General Michael Flynn was “abusive with staff, didn’t listen, worked against policy, bad management.” Add this pick to Steve Bannon from Breitbart media as the White House Chief Strategist and it is easy to see why many people on the left are scared of what could come out of the new administration. One positive thing that has come out of Trump being elected is a bull market run in the financial markets that, for the most part, investors will not complain about. However, it appears the rally in the market could be short lived as much of the gains of the past two weeks have been predicated on Trump actually being able to get the US economy growing faster than it has the past few years and on inflation picking up. While many of President-Elect Trump’s ideas sound good to the financial markets, there seems to be more and more hesitation about how he will pay for everything he is talking about doing. Fears of the national debt ballooning seems to be appropriate if all of the tax cuts and spending increases occur and even then it will only be possible if Trump works with Congress enough to get a budget passed.
Global news impacting the markets:
Two different parts of the world made headlines last week that impacted some of the foreign markets, with the first being Europe and the second being Asia. On Thursday, the European Central Bank (ECB) released its detailed meeting minutes from the previous meeting. While there were a number of positives that the committee pointed out during the meeting, there continued to be an overarching cautious tone set in the minutes. In light of the meeting minutes, the odds of any substantial changes in monetary policies from the ECB moved lower over the course of the week. Potentially in the cards for the December meeting is an extension of the current quantitative easing program that the ECB is undertaking. This was anticipated at the last meeting and did not materialize. This could help boost the slow growth and potentially increase the painfully slow inflation rates currently being seen across much of Europe. Two big wild cards at the meeting were the outcomes of the Brexit vote and the US presidential election. The Brexit remains unclear since the high court in the UK ruled that the Prime minister does not have the authority to trigger article 50. This has led the government to contest the ruling in a court of appeals in early December and PM Theresa May to saying that she will be moving forward with article 50 in March of 2017; effectively starting the two year clock on the UK’s leaving the EU. Pertaining to the US election, even knowing the outcome of the election, it will be no less of a wild card at the December meeting as there is a lot of uncertainty over what President Trump will do with trade agreements and NATO, just to name two topics that impact both the EU and the US. Europe was not the only region of the world to make headlines last week in the media as Asia made both positive and negative headlines.
Fears over what President Trump could do in office are as real in Asia as they are for the ECB, as much of Asia’s regional economy depends on trade with the US. While the US moving into an all-out trade war seems unlikely, there could be significant pressure on the region to allow for US manufacturing to become more competitive. We have seen wild moves in both equity markets in Asia as well as currencies and bonds in light of the US election and looming rate hike from the US Fed. The news out of Asia last week was not all negative, however. Japan reported its Q3 GDP figure at 2.2 percent, much higher than the expected sub one percent reading and industrial output in China was higher than expected in the September data. A negative in the data out of China last week, however, was that retail sales for the month of October missed expectations of 10.7 percent, coming in at a 10 percent growth rate on a year-over-year basis. This double digit gain in retail sales is significant because it is one data point that points to the success of the Chinese government’s willingness to transform the Chinese economy from an export driven economy into a more internal consumption based economy.
Technical market review:
Last week’s market performance was almost the opposite of what we saw two weeks ago on the announcement of the Trump victory, with the Dow consolidating a bit for the week, while the Technology heavy NASDAQ pushed higher. In the charts below, the blue lines represent the closest level of support/ resistance for each of the indexes, established by points the markets have touched in the past prior to bouncing higher. The red lines represent the upper edge of the most recent trading range on each of the three major indexes. For the VIX, the red line remains the rolling 52-week average level of the VIX.
As you can see, the Dow (upper right pane above) remains well above the upper-most resistance level from the indexes’ most recent trading range after jumping higher on the Trump win. The large increase in the Dow is a bit unusual when looking back in the historical data as the Dow is composed mainly of large blue chips companies that are slow movers in both business and the markets. It appears that either the other two indexes have a large amount of catch-up to play or that the Dow has some downside building as it needs to move down closer to the other two indexes. Both the NASDAQ (lower left pane above) and the S&P 500 (upper left pane above) now find themselves near the top end of their trading ranges with both essentially bumping the red line. If we can get both the S&P 500 and the NASDAQ to break above their respective trading ranges, it would be a positive sign for the rally seen over the past two weeks, but it looks like the rally may be starting to fade. The trading this week will largely be ignored by technical investors as volume is expected to be very light as money managers and investors alike take a break from the markets for the Thanksgiving holiday. The VIX is pricing this type of slowdown in market movements as well as it is now right back down at the low levels that we saw well before all of the rhetoric of the US election.
Hybrid model performance and update
For the trading week ending on 11/18/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:
| |
Last Week |
2016 YTD |
Since 6/30/2015 |
| Aggressive Model |
0.52% |
-0.23% |
4.06% |
| Aggressive Benchmark |
-0.03% |
2.34% |
-2.87% |
| Growth Model |
0.23% |
0.14% |
3.48% |
| Growth Benchmark |
-0.02% |
2.00% |
-1.96% |
| Moderate Model |
-0.92% |
0.46% |
3.19% |
| Moderate Benchmark |
-0.01% |
1.57% |
-1.17% |
| Income Model |
-0.27% |
0.59% |
3.22% |
| Income Benchmark |
0.00% |
0.98% |
-0.32% |
| S&P 500 |
0.81% |
6.75% |
5.76% |
*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.
Last week there was one change made in the Hybrid models and that was the addition of a new fund, the Powershares Global High Yield Short Duration bond fund (ticker PGHY). I’m currently in the process of moving toward this fund in the models as the fund has a very strong dividend payout of nearly 6 percent and is in an area of the fixed income market that could benefit from the current situation, both in Washington DC and from the Fed. The positions purchased last week are one third of a full position and the position will be filled as positions in other holdings are sold. In the stocks within the hybrid models we continue to move through earnings season with only a few more reports to go, one of which is occurring this week with Hormel. Hormel should have had a good third quarter as its raw material costs declined during the quarter, but the results will really depend on consumer tastes during the quarter. The company is currently on my “watch closely” list to make sure that things are going in the correct direction from a business standpoint. Wal-Mart moved lower this week after announcing better than expected earnings for the third quarter and reaffirming its outlook for the remainder of the year. The street was expecting more lofty results after stronger than expected results were posted by some competitors. Overall fundamentals for the company remain strong as its online sales unit picked up during the third quarter as it attempts to steal some market share away from competitors such as Amazon. Cash levels in the models will likely be coming down over the coming weeks as investment opportunities present themselves and the tactical portion of the models position for what will likely turn in to a year-end Santa Rally, after what looks like a rate hike gift from the Fed.
Market Statistics:
As mentioned above, the movement of the three main US indexes last week was almost the opposite of what we saw two weeks ago in reaction to the outcome of the Presidential election:
| Index |
Change |
Volume |
| NASDAQ |
1.61% |
Average |
| S&P 500 |
0.81% |
Average |
| Dow |
0.11% |
Average |
Volume, as expected, moderated a lot from the very high levels we saw following the US election two weeks ago to the average volume levels last week. Corporate earnings announcements and a moderation in some of Trump’s stances seemed to be the primary driving forces behind last week’s market movements.
When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:
| Top 5 Sectors |
Change |
|
Bottom 5 Sectors |
Change |
| Semiconductors |
4.85% |
|
Biotechnology |
-1.14% |
| Regional Banks |
3.99% |
|
International Real Estate |
-1.22% |
| Broker Dealers |
3.90% |
|
Materials |
-1.62% |
| Healthcare Providers |
3.79% |
|
Healthcare |
-1.76% |
| Home Construction |
3.47% |
|
Pharmaceuticals |
-2.19% |
Financial related sectors of the financial markets made up 2 of the top five performing sectors last week as speculation about deregulation of the financial industry continued to have a trickledown effect on the groups. Semiconductors popped last week, thanks to a large merger announcement as well as continued and increasing demand for semiconductors in many of the latest computer chips that run all of the latest electronic devices. Healthcare providers made it onto the top 5 list, thanks to a bump seen from Trump walking back his once adamant full repeal of the Affordable Care Act (ACA). On The flipside last week, Biotechnology and Pharmaceuticals made the switch from winning sectors two weeks ago to losing sectors last week; the outside gains realized after the Trump victory were short lived because people still think the industry has a common practice of price gauging, which means continued negative press, regardless of who occupies the White House. The other three sectors that made the bottom sector performance last week were almost random in their reasons for doing so with Materials being just a slight pull back after running so much, International Real Estate seeming to move on the value of the dollar and Healthcare moving for no apparent reason.
With the prospects of higher rates coming in December, fixed income last week moved lower in the US with the middle of the curve seeing the largest declines:
| Fixed Income |
Change |
| Long (20+ years) |
-0.98% |
| Middle (7-10 years) |
-1.36% |
| Short (less than 1 year) |
0.01% |
| TIPS |
-0.81% |
Global currency trading volume was above average last week, as investors around the world pushed the US dollar higher. Overall, the US dollar advanced 2.34 percent against a basket of international currencies, giving the green back a nearly five and a half percent increase over just the past two weeks. The best performing of the global currencies last week was the Egyptian Pound, as it gained 1.65 percent against the US dollar. Much of this gain was seen as a small bounce after the currency fell by more than 40 percent three weeks ago. The worst performance among the global currencies was seen in the Japanese Yen, as it declined by 3.74 percent against the value of the US dollar. Much of the decline in the Yen was due to uncertainty over a future trade war with the US and the potential negative impact that such a war would have on exporters within Japan.
Commodities were mixed last week as oil jumped higher, while metals continued to push lower:
| Metals |
Change |
|
Commodities |
Change |
| Gold |
-1.67% |
|
Oil |
5.63% |
| Silver |
-4.49% |
|
Livestock |
1.29% |
| Copper |
-1.49% |
|
Grains |
1.06% |
| |
|
|
Agriculture |
-0.10% |
The overall Goldman Sachs Commodity Index gained 2.59 percent last week, thanks in large part to the more than 5 percent gain in the price of oil. Oil advanced by 5.63 percent as there are now rumors that a production freeze could be in the works before the end of the year by OPEC. It seems ludicrous that oil should move as much as it does on nothing but rumors, some of which I am sure are started by OPEC members itself just to boost prices. After jumping more than 12 percent two weeks ago it was not surprising to see that Copper gave back a little of the gains last week, falling 1.49 percent during the week. Gold and Silver continued their trends of moving lower, falling 1.67 and 4.49 percent, respectively. Soft commodities were mixed with Agriculture overall falling 0.10 percent, while Livestock gained 1.29 percent and Grains posted gains of 1.06 percent.
| Top 2 Indexes |
Country |
Change |
|
Bottom 2 Indexes |
Country |
Change |
| Caracas General |
Venezuela |
9.3% |
|
WIG |
Poland |
-3.17% |
| CASE 30 |
Egypt |
5.0% |
|
FTSE MIB |
Italy |
-3.25% |
Last week was a mixed week in terms of international index performances, with 55 percent of the global indexes experiencing gains for the week. The best performing index last week was found in Venezuela and was the Caracas General index, which turned in a gain of 9.3 percent for the week. This gain in the index brings the two-week gain up to more than 50 percent, as the political situation within the country seems to be leaning toward tossing current President Maduro out of office early next year. The worst performing index for the week was found in Italy and was the FTSE MIB, which turned in a loss of 3.25 percent. Italy once again saw international money managers focus on the weakness in its banking system and on the upcoming election, upon which the current Prime Minister has staked his office.
After back to back weeks of the VIX moving by more than 40 percent, last week’s decline of only 9.3 percent seems almost tame. It appears the VIX is not reading much volatility into the markets over the next 30 days as the current Obama administration starts to hand off control of the US government to the incoming Trump administration. Much of the lowered expectations of risk probably has a good deal to do with the time of year we are in when people are generally more upbeat about the holiday season and, in turn, the economy overall and not looking for potential negatives that could impact the financial markets. The current reading of 12.85 implies that a move of 3.71 percent is likely to occur over the next 30 days. The direction of the move over the next 30 days is unknown.
Economic Release Calendar:
Last week the economic news releases that were released were average in terms of number, but lacking in terms of impact:
| Economic Impact |
Date |
Economic News Release |
Date Range |
Actual |
Expectation |
| Slightly Positive |
11/15/2016 |
Retail Sales |
October 2016 |
0.80% |
0.60% |
| Slightly Positive |
11/15/2016 |
Retail Sales ex-auto |
October 2016 |
0.80% |
0.50% |
| Slightly Positive |
11/15/2016 |
Empire Manufacturing |
November 2016 |
1.5 |
-0.5 |
| Slightly Negative |
11/16/2016 |
PPI |
October 2016 |
0.00% |
0.30% |
| Slightly Negative |
11/16/2016 |
Core PPI |
October 2016 |
-0.20% |
0.20% |
| Neutral |
11/17/2016 |
CPI |
October 2016 |
0.40% |
0.40% |
| Neutral |
11/17/2016 |
Core CPI |
October 2016 |
0.10% |
0.20% |
| Neutral |
11/17/2016 |
Housing Starts |
October 2016 |
1323K |
1178K |
| Neutral |
11/17/2016 |
Building Permits |
October 2016 |
1229K |
1200K |
| Neutral |
11/17/2016 |
Philadelphia Fed |
November 2016 |
7.6 |
7.0 |
Data for table from Econoday.com, Bloomberg and Yahoo Finance
Last week the economic news releases started on Tuesday with the release of the retail sales figures for the month of October, with both overall retail sales and retail sales excluding auto sales coming in with gains of 0.8 percent, slightly higher than anticipated, but not strong enough to signal strong growth in the US economy. Much to some investors’ relief, the Empire Manufacturing index, which was also released on Tuesday, came in with a positive reading of 1.5 compared to the -0.5 reading that was expected. This 1.5 reading signifies very slow growth in manufacturing in the US, but growth nonetheless. On Wednesday, the Producer Price Index (PPI) was released with both core and overall prices at the producer level coming in lower than expected, thanks in large part to reduced raw material input costs. On Thursday the Consumer Price Index (CPI) for the month of October came in in-line with market expectations and had very little overall impact on the markets or on the Fed’s thinking about the future timing of raising interest rates. Housing starts and building permits both for the month of October also were released on Friday, with both figures coming in close to market expectations. Wrapping up the day on Thursday was the release of the Philadelphia Fed Index for the month of November, which came in very close to expectations of 7 when it posted a reading of 7.6 and had little overall impact on the markets. Getting an honorable mention this week, despite it not being in the weekly table, was the release of the weekly jobless claims, which posted a reading of 235,000, the lowest level that we have seen on the data set going back 43 years to 1973. Continuing jobless claims also continued to decline last week, posting at levels not seen in the last 16 years. These two figures are not included in the weekly table as they very rarely do anything of significance, but with these two milestones being hit, I thought it would be prudent to mention them.
This week is a shortened trading week with a much smaller than typical economic news release table:
| Date |
Release |
Release Range |
Market Expectation |
| 11/22/2016 |
Existing Home Sales |
October 2016 |
5.40M |
| 11/23/2016 |
Durable Orders |
October 2016 |
1.10% |
| 11/23/2016 |
Durable Orders, Ex- Transportation |
October 2016 |
0.30% |
| 11/23/2016 |
University of Michigan Consumer Sentiment Index |
November 2016 |
91.6 |
| 11/23/2016 |
New Home Sales |
October 2016 |
587K |
| 11/23/2016 |
FOMC Minutes |
Previous Meeting |
N/A |
Data for table from Econoday.com, Bloomberg and Yahoo Finance
This week the economic news releases start on Tuesday with the release of the existing home sales for the month of October, which is expected to post a reading of 5.4 million units during the month. Wednesday is a busy day, but it is also the last day of the week for releases as Durable goods orders for the month of October kicks things off. Overall durable goods orders are expected to have increased by 1.1 percent during the month, while orders excluding transportation are expected to have increased by 0.3 percent. Both of these figures are very low when compared to historical figures for this stage in the economic cycle. New home sales as well as the minutes from the November FOMC meeting will be released later during the day on Wednesday, but it is unlikely that by this time many people will still be at work watching the markets and reacting to the releases. Wrapping up the week on Wednesday this week is the middle of October reading for the University of Michigan’s Consumer sentiment index, which is expected to be unchanged from the end of October reading. Remember that this reading was largely taken prior to the outcome of the US election being known, so we could see a sizeable difference at the end of November reading in two weeks, once the impact of the election is calculated in the figure. With this being a holiday week, you may expect that there are no scheduled speeches by Fed officials during the week.
Interesting Fact —Thanksgiving fun fact
Turkey is the traditional dish for the Thanksgiving feast. In the US, about 280 million turkeys are sold for the Thanksgiving celebrations. There is no official reason or declaration for the use of turkey. They just happened to be the most plentiful meat available at the time of the first Thanksgiving in 1621, starting the tradition.
Source: http://www.coolest-holiday-parties.com/
Peter's Stock Market Blog
Financial Market Commentary November 21st 2016
November 21, 2016
For a PDF version of the below commentary please click here weekly-letter-11-21-2016
Commentary quick take:
Major theme of the markets last week: Ready for rate blast off?
The major theme of the financial markets last week was Fed Chair Janet Yellen’s testimony before Congress and the revelation that the Fed is now almost certainly going to be raising rates at the December meeting. With the fear of appearing too political by raising rates at the November meeting now behind the Fed, Chair Yellen gave prepared remarks about the current state of the US economy, in which she outlined pretty clearly that baring some anomaly in the data that comes out over the next three weeks, the Fed will be increasing rates at the December meeting. In fact, the Fed watch numbers currently have the odds of a rate hike at 100 percent. With rates moving higher and President Trump filling in the blanks in his administration in terms of personnel, we could be in for an exciting time in the financial markets, both on fixed income and equity investments. If the Fed manages to raise rates in December it will be the only hike it pulled off during 2016. Going into the year, you may remember that many Fed officials were calling for as many as four hikes throughout 2016. This, interestingly enough, is the number of hikes the markets are now pricing in for 2017, despite all of the uncertainty about the situation in Washington DC. The year 2017 is setting up to be a very interesting year, both here in the US and around the world.
US news impacting the financial markets:
Federal Reserve Chair Janet Yellen headlined the financial news last week as she testified before Congress on Thursday. She was speaking before the Joint Economic Committee and provided her prepared remarks, followed by several hours of questions and answers from both sides of the political aisle. The following short paragraph in her prepared remarks is what Wall Street really latched on to:
“At our meeting earlier this month, the Committee judged that the case for an increase in the target range had continued to strengthen and that such an increase could well become appropriate relatively soon if incoming data provide some further evidence of continued progress toward the Committee’s objectives. This judgment recognized that progress in the labor market has continued and that economic activity has picked up from the modest pace seen in the first half of this year. And inflation, while still below the Committee’s 2 percent objective, has increased somewhat since earlier this year. Furthermore, the Committee judged that near-term risks to the outlook were roughly balanced.”
Shortly after she said the above paragraph, the odds of a rate hike at the December meeting, which is only a few short weeks away, went to 100 percent. The odds of rates moving higher at meetings in 2017 also increased. Four rate hikes during 2017 is likely. With near certainty of a rate hike in December, the bond market in the US adjusted lower and losses that started with the surprise Trump victory seemed to carry over a second week last week. Corporate earnings continued to impact the overall markets last week as we continue to see a strong third quarter for corporate America.
Companies that reported earnings last week focused on the retail US consumer as we are now very close to the end of the third quarter reporting period and retailers are always some of the last companies to report earnings. Below is a table of the well-known companies that released earnings last week, with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:
One theme last week in the earnings was that the big box and discount retailers performed well during the third quarter. Ross stores turned in the top performance of the group last week, beating expectations by 11 percent, while rival TJ Maxx beat expectations by only 5 percent. Wal-Mart and Target were both closely watched, with Target seeing a higher upside surprise than Wal-Mart, but both turned in solid quarters. Both companies forecast strong sales around the holiday season, which officially kicks off on Friday morning across the US with Black Friday sales. Higher-end clothing retailers Abercrombie & Fitch and Buckle both struggled during the quarter as fall and the first part of winter was warmer than expected across much of the US, leading to less early season shopping for winter clothing. With such poor performance in the third quarter, the companies will likely see better than anticipated sales in the fourth quarter as consumers finally start to feel the colder temperatures and shift their wardrobes to winter attire. The home improvement sector’s two main companies, Home Depot and Lowe’s, both reported earnings last week with Home Depot earning slightly more than expected, while Lowe’s fell short. Both companies blamed the lack of sales on the weather in the US, much like the higher-end retail clothing companies.
According to Factset Research, we have seen 477 (95 percent) of the S&P 500 companies release their results for the third quarter of 2016. Of the 477 that have released, 72 percent have beaten earnings expectations, while 7 percent have met expectations and 21 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 55 percent of the companies have beaten estimates, while 45 percent have fallen short. Both the revenue figures as well as the earnings per share figures stayed relatively unchanged, when compared to the levels seen two weeks ago. The earnings figures above are within 1 percent of the 5-year average level, while the revenue figures are equal to the 5-year average level that we have seen on the S&P 500. The overall blended earnings growth rate that has been seen so far for the S&P 500 is 3.0 percent, which is significantly better than the anticipated -2.2 percent that was expected going into the quarter. With only 5 percent of the companies in the S&P 500 needing to report earnings, it is becoming increasingly unlikely that the above mentioned figures will change by a material amount between now and the end of the reporting season.
With Thanksgiving occurring on Thursday this week, it is not surprising to see a very low number of companies reporting earnings this week as we move into the final three weeks of third quarter earnings season. The table of well-known companies below shows the companies that have the greatest potential to move the markets highlighted in green:
Consumer facing retail companies once again make up the majority of companies that are reporting earnings this week. Deere & Co is one company that will be closely watched by Wall Street this week as its products are used in many different businesses and slowdowns in a variety of sectors can be seen early on in the company’s revenue figures. Three of the major food producers in the country (Tyson, Hormel and Campbell’s) report earnings this week with fairly lofty expectations for the third quarter, thanks in large part to declining commodities prices, which were mostly not passed along to the end consumer. The final news last week here in the US that impacted the financial markets was political as President-Elect trump continues to fill out his cabinet.
Keeping with the political outsider theme that he ran with for much of his campaign, President-Elect Trump moved forward last week with filling a few key spots in his administration. He appointed Jeff Sessions as Attorney General. He picked Lt. General Michael Flynn as his national security adviser; a controversial pick as he was dismissed by President Obama. In former Secretary of State Colin Powell’s words, General Michael Flynn was “abusive with staff, didn’t listen, worked against policy, bad management.” Add this pick to Steve Bannon from Breitbart media as the White House Chief Strategist and it is easy to see why many people on the left are scared of what could come out of the new administration. One positive thing that has come out of Trump being elected is a bull market run in the financial markets that, for the most part, investors will not complain about. However, it appears the rally in the market could be short lived as much of the gains of the past two weeks have been predicated on Trump actually being able to get the US economy growing faster than it has the past few years and on inflation picking up. While many of President-Elect Trump’s ideas sound good to the financial markets, there seems to be more and more hesitation about how he will pay for everything he is talking about doing. Fears of the national debt ballooning seems to be appropriate if all of the tax cuts and spending increases occur and even then it will only be possible if Trump works with Congress enough to get a budget passed.
Global news impacting the markets:
Two different parts of the world made headlines last week that impacted some of the foreign markets, with the first being Europe and the second being Asia. On Thursday, the European Central Bank (ECB) released its detailed meeting minutes from the previous meeting. While there were a number of positives that the committee pointed out during the meeting, there continued to be an overarching cautious tone set in the minutes. In light of the meeting minutes, the odds of any substantial changes in monetary policies from the ECB moved lower over the course of the week. Potentially in the cards for the December meeting is an extension of the current quantitative easing program that the ECB is undertaking. This was anticipated at the last meeting and did not materialize. This could help boost the slow growth and potentially increase the painfully slow inflation rates currently being seen across much of Europe. Two big wild cards at the meeting were the outcomes of the Brexit vote and the US presidential election. The Brexit remains unclear since the high court in the UK ruled that the Prime minister does not have the authority to trigger article 50. This has led the government to contest the ruling in a court of appeals in early December and PM Theresa May to saying that she will be moving forward with article 50 in March of 2017; effectively starting the two year clock on the UK’s leaving the EU. Pertaining to the US election, even knowing the outcome of the election, it will be no less of a wild card at the December meeting as there is a lot of uncertainty over what President Trump will do with trade agreements and NATO, just to name two topics that impact both the EU and the US. Europe was not the only region of the world to make headlines last week in the media as Asia made both positive and negative headlines.
Fears over what President Trump could do in office are as real in Asia as they are for the ECB, as much of Asia’s regional economy depends on trade with the US. While the US moving into an all-out trade war seems unlikely, there could be significant pressure on the region to allow for US manufacturing to become more competitive. We have seen wild moves in both equity markets in Asia as well as currencies and bonds in light of the US election and looming rate hike from the US Fed. The news out of Asia last week was not all negative, however. Japan reported its Q3 GDP figure at 2.2 percent, much higher than the expected sub one percent reading and industrial output in China was higher than expected in the September data. A negative in the data out of China last week, however, was that retail sales for the month of October missed expectations of 10.7 percent, coming in at a 10 percent growth rate on a year-over-year basis. This double digit gain in retail sales is significant because it is one data point that points to the success of the Chinese government’s willingness to transform the Chinese economy from an export driven economy into a more internal consumption based economy.
Technical market review:
Last week’s market performance was almost the opposite of what we saw two weeks ago on the announcement of the Trump victory, with the Dow consolidating a bit for the week, while the Technology heavy NASDAQ pushed higher. In the charts below, the blue lines represent the closest level of support/ resistance for each of the indexes, established by points the markets have touched in the past prior to bouncing higher. The red lines represent the upper edge of the most recent trading range on each of the three major indexes. For the VIX, the red line remains the rolling 52-week average level of the VIX.
As you can see, the Dow (upper right pane above) remains well above the upper-most resistance level from the indexes’ most recent trading range after jumping higher on the Trump win. The large increase in the Dow is a bit unusual when looking back in the historical data as the Dow is composed mainly of large blue chips companies that are slow movers in both business and the markets. It appears that either the other two indexes have a large amount of catch-up to play or that the Dow has some downside building as it needs to move down closer to the other two indexes. Both the NASDAQ (lower left pane above) and the S&P 500 (upper left pane above) now find themselves near the top end of their trading ranges with both essentially bumping the red line. If we can get both the S&P 500 and the NASDAQ to break above their respective trading ranges, it would be a positive sign for the rally seen over the past two weeks, but it looks like the rally may be starting to fade. The trading this week will largely be ignored by technical investors as volume is expected to be very light as money managers and investors alike take a break from the markets for the Thanksgiving holiday. The VIX is pricing this type of slowdown in market movements as well as it is now right back down at the low levels that we saw well before all of the rhetoric of the US election.
Hybrid model performance and update
For the trading week ending on 11/18/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:
*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.
Last week there was one change made in the Hybrid models and that was the addition of a new fund, the Powershares Global High Yield Short Duration bond fund (ticker PGHY). I’m currently in the process of moving toward this fund in the models as the fund has a very strong dividend payout of nearly 6 percent and is in an area of the fixed income market that could benefit from the current situation, both in Washington DC and from the Fed. The positions purchased last week are one third of a full position and the position will be filled as positions in other holdings are sold. In the stocks within the hybrid models we continue to move through earnings season with only a few more reports to go, one of which is occurring this week with Hormel. Hormel should have had a good third quarter as its raw material costs declined during the quarter, but the results will really depend on consumer tastes during the quarter. The company is currently on my “watch closely” list to make sure that things are going in the correct direction from a business standpoint. Wal-Mart moved lower this week after announcing better than expected earnings for the third quarter and reaffirming its outlook for the remainder of the year. The street was expecting more lofty results after stronger than expected results were posted by some competitors. Overall fundamentals for the company remain strong as its online sales unit picked up during the third quarter as it attempts to steal some market share away from competitors such as Amazon. Cash levels in the models will likely be coming down over the coming weeks as investment opportunities present themselves and the tactical portion of the models position for what will likely turn in to a year-end Santa Rally, after what looks like a rate hike gift from the Fed.
Market Statistics:
As mentioned above, the movement of the three main US indexes last week was almost the opposite of what we saw two weeks ago in reaction to the outcome of the Presidential election:
Volume, as expected, moderated a lot from the very high levels we saw following the US election two weeks ago to the average volume levels last week. Corporate earnings announcements and a moderation in some of Trump’s stances seemed to be the primary driving forces behind last week’s market movements.
When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:
Financial related sectors of the financial markets made up 2 of the top five performing sectors last week as speculation about deregulation of the financial industry continued to have a trickledown effect on the groups. Semiconductors popped last week, thanks to a large merger announcement as well as continued and increasing demand for semiconductors in many of the latest computer chips that run all of the latest electronic devices. Healthcare providers made it onto the top 5 list, thanks to a bump seen from Trump walking back his once adamant full repeal of the Affordable Care Act (ACA). On The flipside last week, Biotechnology and Pharmaceuticals made the switch from winning sectors two weeks ago to losing sectors last week; the outside gains realized after the Trump victory were short lived because people still think the industry has a common practice of price gauging, which means continued negative press, regardless of who occupies the White House. The other three sectors that made the bottom sector performance last week were almost random in their reasons for doing so with Materials being just a slight pull back after running so much, International Real Estate seeming to move on the value of the dollar and Healthcare moving for no apparent reason.
With the prospects of higher rates coming in December, fixed income last week moved lower in the US with the middle of the curve seeing the largest declines:
Global currency trading volume was above average last week, as investors around the world pushed the US dollar higher. Overall, the US dollar advanced 2.34 percent against a basket of international currencies, giving the green back a nearly five and a half percent increase over just the past two weeks. The best performing of the global currencies last week was the Egyptian Pound, as it gained 1.65 percent against the US dollar. Much of this gain was seen as a small bounce after the currency fell by more than 40 percent three weeks ago. The worst performance among the global currencies was seen in the Japanese Yen, as it declined by 3.74 percent against the value of the US dollar. Much of the decline in the Yen was due to uncertainty over a future trade war with the US and the potential negative impact that such a war would have on exporters within Japan.
Commodities were mixed last week as oil jumped higher, while metals continued to push lower:
The overall Goldman Sachs Commodity Index gained 2.59 percent last week, thanks in large part to the more than 5 percent gain in the price of oil. Oil advanced by 5.63 percent as there are now rumors that a production freeze could be in the works before the end of the year by OPEC. It seems ludicrous that oil should move as much as it does on nothing but rumors, some of which I am sure are started by OPEC members itself just to boost prices. After jumping more than 12 percent two weeks ago it was not surprising to see that Copper gave back a little of the gains last week, falling 1.49 percent during the week. Gold and Silver continued their trends of moving lower, falling 1.67 and 4.49 percent, respectively. Soft commodities were mixed with Agriculture overall falling 0.10 percent, while Livestock gained 1.29 percent and Grains posted gains of 1.06 percent.
Last week was a mixed week in terms of international index performances, with 55 percent of the global indexes experiencing gains for the week. The best performing index last week was found in Venezuela and was the Caracas General index, which turned in a gain of 9.3 percent for the week. This gain in the index brings the two-week gain up to more than 50 percent, as the political situation within the country seems to be leaning toward tossing current President Maduro out of office early next year. The worst performing index for the week was found in Italy and was the FTSE MIB, which turned in a loss of 3.25 percent. Italy once again saw international money managers focus on the weakness in its banking system and on the upcoming election, upon which the current Prime Minister has staked his office.
After back to back weeks of the VIX moving by more than 40 percent, last week’s decline of only 9.3 percent seems almost tame. It appears the VIX is not reading much volatility into the markets over the next 30 days as the current Obama administration starts to hand off control of the US government to the incoming Trump administration. Much of the lowered expectations of risk probably has a good deal to do with the time of year we are in when people are generally more upbeat about the holiday season and, in turn, the economy overall and not looking for potential negatives that could impact the financial markets. The current reading of 12.85 implies that a move of 3.71 percent is likely to occur over the next 30 days. The direction of the move over the next 30 days is unknown.
Economic Release Calendar:
Last week the economic news releases that were released were average in terms of number, but lacking in terms of impact:
Data for table from Econoday.com, Bloomberg and Yahoo Finance
Last week the economic news releases started on Tuesday with the release of the retail sales figures for the month of October, with both overall retail sales and retail sales excluding auto sales coming in with gains of 0.8 percent, slightly higher than anticipated, but not strong enough to signal strong growth in the US economy. Much to some investors’ relief, the Empire Manufacturing index, which was also released on Tuesday, came in with a positive reading of 1.5 compared to the -0.5 reading that was expected. This 1.5 reading signifies very slow growth in manufacturing in the US, but growth nonetheless. On Wednesday, the Producer Price Index (PPI) was released with both core and overall prices at the producer level coming in lower than expected, thanks in large part to reduced raw material input costs. On Thursday the Consumer Price Index (CPI) for the month of October came in in-line with market expectations and had very little overall impact on the markets or on the Fed’s thinking about the future timing of raising interest rates. Housing starts and building permits both for the month of October also were released on Friday, with both figures coming in close to market expectations. Wrapping up the day on Thursday was the release of the Philadelphia Fed Index for the month of November, which came in very close to expectations of 7 when it posted a reading of 7.6 and had little overall impact on the markets. Getting an honorable mention this week, despite it not being in the weekly table, was the release of the weekly jobless claims, which posted a reading of 235,000, the lowest level that we have seen on the data set going back 43 years to 1973. Continuing jobless claims also continued to decline last week, posting at levels not seen in the last 16 years. These two figures are not included in the weekly table as they very rarely do anything of significance, but with these two milestones being hit, I thought it would be prudent to mention them.
This week is a shortened trading week with a much smaller than typical economic news release table:
Data for table from Econoday.com, Bloomberg and Yahoo Finance
This week the economic news releases start on Tuesday with the release of the existing home sales for the month of October, which is expected to post a reading of 5.4 million units during the month. Wednesday is a busy day, but it is also the last day of the week for releases as Durable goods orders for the month of October kicks things off. Overall durable goods orders are expected to have increased by 1.1 percent during the month, while orders excluding transportation are expected to have increased by 0.3 percent. Both of these figures are very low when compared to historical figures for this stage in the economic cycle. New home sales as well as the minutes from the November FOMC meeting will be released later during the day on Wednesday, but it is unlikely that by this time many people will still be at work watching the markets and reacting to the releases. Wrapping up the week on Wednesday this week is the middle of October reading for the University of Michigan’s Consumer sentiment index, which is expected to be unchanged from the end of October reading. Remember that this reading was largely taken prior to the outcome of the US election being known, so we could see a sizeable difference at the end of November reading in two weeks, once the impact of the election is calculated in the figure. With this being a holiday week, you may expect that there are no scheduled speeches by Fed officials during the week.
Interesting Fact —Thanksgiving fun fact
Turkey is the traditional dish for the Thanksgiving feast. In the US, about 280 million turkeys are sold for the Thanksgiving celebrations. There is no official reason or declaration for the use of turkey. They just happened to be the most plentiful meat available at the time of the first Thanksgiving in 1621, starting the tradition.
Source: http://www.coolest-holiday-parties.com/
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