With “Fed week” out of the way, investors might have thought they would get a break from monetary policy and more wild market swings in the days ahead. No dice.
An incredible 14 Fed speeches are scheduled this week following a big turnaround in a wild overnight session Monday. If even a handful of Fed speakers have as much impact as St. Louis Fed President James Bullard’s comments Friday about a possible 2022 rate increase and less need for the Fed to buy mortgage-backed securities, we could have an interesting few days. Especially tomorrow, when Fed Chair Jerome Powell appears for testimony on Capitol Hill. He’s scheduled to discuss COVID, but could get asked about possible tapering of monetary stimulus.
Bullard’s remarks Friday—following a more hawkish tone from the Fed meeting—slammed the market like a double left hook going into the weekend. Investors had been worried that the Fed might get caught complacent about rising inflation, but instead the Fed caught the market being complacent about Fed policy.
Summer Doldrums? We Hardly Knew You
Any complacency on Wall Street left town in a hurry late last week as the Cboe Volatility Index () quickly jumped above 20 by Friday from below 16 a few days before and remained above 20 this morning. No one had to wait long for volatility to make an appearance, as major indices turned green in pre-market trading this morning following a much lower start to the overnight session.
Friday’s quadruple witching—the one day each quarter when contracts for stock index futures, stock index options, stock options and single-stock futures all expire—saw the biggest move we’ve had on a quadruple witching day in almost a decade. A crazy overnight session followed, with an initial downturn amid some hedging after Friday’s expiration and then an up-move following the open in Europe. Some of this wild action might carry through into the regular session today, so anyone trading early on might want to stay on their toes. Things have been all over the place with no pattern.
And speaking of volatility, the cryptocurrency market has been taking it on the chin in recent days—and again this morning—after China announced a crackdown on crypto mining. futures (/BTC) begin the week with an 8% drop.
Meanwhile, the —which a week ago was testing 2021 lows—reversed course to test 2021 highs in just a few days. A lot of talk over the weekend was about how the supposed “summer doldrums” in the markets might already be over.
The Fed’s left hook hasn’t hit the entire market square in the face. Parts look more black and blue than others. While the had its worst week since January, the tech-heavy actually finished the week without much damage.
This could reflect something we mentioned before the Fed meeting about how some of the “mega-cap” tech stocks like Apple (NASDAQ:) and Microsoft (NASDAQ:) seem to draw investors during uncertain times. We saw the entire so-called “FAANG” group leap in 2020 during the pandemic, and now some of its members, including AAPL and Amazon (NASDAQ:), appear to be benefiting again from this rate and inflation uncertainty.
That’s a 180 from earlier this year, when worries about rising inflation sent “growth” stocks, especially tech, out to the woodshed for months. Back then, there were concerns that rising Treasury yields could trim growth prospects for tech companies, many of which have high values based on anticipated future earnings growth. There’s been a bifurcation since then, with the mega-caps now seen by some analysts as less likely to be hurt by higher rates. A mature company like MSFT or AAPL is hardly the same as a small software or chip firm with much of its growth potential in future years.
FAANGs weren’t the only ones keeping their heads above water. Tech stocks like Adobe (NASDAQ:) and Nvidia (NASDAQ:) also had great weeks despite the Fed worries. Some aspects of tech, like the cloud (a strength of ADBE) and chips (NVDA is an industry leader), are sometimes thought of as the “cyclical” parts of tech, meaning they tend to do well in a growing economy. We’re in an inflationary, high growth environment, which would normally help cyclicals and appears to be helping stocks like ADBE and NVDA.
“Value” Trade Loses Weekly Tug-Of-War
What’s not getting helped? The same cyclicals that led us to where we are. Materials, industrials and financials took it on the chin late last week after months of outpacing tech amid reopening strength. If rate worries are really starting to dominate, the fear might be that higher yields could slow the fast earnings and growth pace we’ve seen through the first half of 2021, weighing on sectors that tend to benefit most from a high-revving economy.
Bullard’s comments went to the heart of that. Before Wednesday, the Fed signalled little chance of a rate hike before 2024. Then on Wednesday it signalled 2023. By Friday, Bullard was talking about 2022. On the other hand, his counterpart, Minneapolis Fed President Neel Kashkari, said Friday he wants to keep rates near zero at least through the end of 2023 to allow the labor market to revive. This kind of Fed speaker tug-of-war might keep the market on its toes all week.
With cyclicals softer, there are signs investors who don’t want to put money into growth sectors are looking for a port in the storm. So-called “defensive” sectors like staples, real estate, utilities and health care could be beneficiaries if this keeps up, analysts said, while we already saw investors pile into fixed income and the dollar last week. Fixed income continued up early Monday as the fell to 1.44%, near recent lows. It did rebound slightly to nearly 1.46% in the hour before the open, and crude oil is bouncing back as well.
Chances for a Fed rate hike this year spiked last week but then cooled off. They’re now around 4%, according to the CME Group’s Fed funds futures complex. The futures market signals a 30% chance that by this time a year from now, the Fed will have hiked at least once, with a 3% chance of two hikes by next June’s Fed meeting. A month ago, the futures market saw only a 20% chance of a rate hike by June 2022.
What’s really interesting now is the dollar going straight up even while Treasury yields fall. The falling yields could signal worries about a possible dip in economic growth, especially with the yield curve now flattening back to where it was in late 2020. When the gap between long-term and short-term bond yields falls, it often, but not always, comes before weakness in the economy.
Prime Day, Key Earnings, Fed Stress Tests Highlight Busy Week
Tired of Fed talk? Maybe it’s time for a shopping trip.
Today is the start of AMZN’s “Prime Day,” an event that goes through tomorrow. According to CNBC, EMarketer forecasts that total digital sales in the U.S. on Prime Day will jump 17.3% year over year to $12.18 billion. Sales made exclusively on AMZN on Prime Day will grow 18.3% from 2020 levels, to $7.31 billion, it said. Some of the product category sales maybe worth monitoring include “back to school” and summer travel items.
Besides Prime Day, investors this week are likely to closely monitor existing and new home sales figures and the personal consumption expenditures (PCE) price index. The PCE data, due Friday, could get closely scrutinized given the market’s focus on inflation at the moment. The core reading that strips out volatile food and energy prices is the Fed’s preferred inflation gauge.
This is normally a light time for earnings. Having said that, a bunch of key companies from important industries are on the calendar this week, so be on the lookout. Some of them include KB Home (NYSE:), Darden Restaurants (NYSE:), Rite Aid (NYSE:), FedEx (NYSE:), Carnival (NYSE:) (NYSE:), Blackberry (TSX:) and Nike (NYSE:). Thursday looks like a crowded earnings day.
CHART OF THE DAY: CRUDE CONUNDRUM. Even as many commodities like (/HG—candlestick) fell sharply last week as the Fed sounded more hawkish and the dollar turned higher, crude (/CL—purple line) kept up its long rally with hardly a pause. Heavy demand amid summer “driving season” and continued low flow from U.S. shale producers have combined to keep crude booming. Data source: CME Group (NASDAQ:). Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.
U.S. Crude Production Growth Stuck: In the traditional description of supply-and-demand economics, when demand rises, that causes prices to rise, which gives producers the incentive to produce more supplies. The first two parts of that equation are working now in the crude market, with rising demand from reopening causing an incredible run in crude oil to the recent nearly three-year highs above $70 a barrel. The third aspect of the equation—rising supply—isn’t playing its part, however. Last week saw production average 11.2 million barrels a day, according to the U.S. Energy Information Administration (EIA). That’s barely above the 11 million average at the end of 2020, and down nearly two million barrels a day from pre-Covid levels.
One thing that could be keeping crude production from reaching the old highs is continued slow progress in the U.S. oil rig count. It climbed by just six in the most recent week to 373, according to Baker Hughes, an oil field services company that tracks the weekly number. That’s up 184 from a year ago when COVID put a heavy lid on demand, but down sharply from 700 or more in the 2015–2020 period.
“Drill, Baby, Drill” Not Such A Blowout Now: The old adage about oil is that it’s easy to shut down production, as the industry did when COVID hit, and a lot harder to ramp it back up. That might be one reason the rigs aren’t coming back as fast as demand. Also, some energy companies operating in the U.S. shale industry have come under pressure to counter global warming by decreasing production, while others have used their cash to pay dividends and pay down debt rather than drill.
There’s no guarantee production can quickly (or ever) return to where it was, but the world’s likely going to need more crude, and before too long. In its latest Monthly Oil Report, the International Energy Agency (IEA) called on OPEC+ to increase production in order to counter higher demand in 2022, trade publication OilPrice.com reported. The IEA expects global oil demand to rise by more than 5 million barrels a day on average next year.
Crude Impact on Equities: Does $70 crude have you worried about the possible economic impact? Well, we were in the same boat about three years ago and crude never really could find much traction above $75. After hitting a peak of $76.90 in October 2018, crude descended to spend most of 2019 between $50 and $60. The SPX had a losing year in 2018 but bounced back in 2019, though you certainly can’t correlate that directly with crude prices. Obviously, one sector tends to do very well in a high crude price environment: Energy.
Despite a steep 3% drop last week after more hawkish talk from the Fed (higher interest rates and an accompanying stronger U.S. dollar tend to weigh on crude), Energy remains the best performing S&P sector year-to-date, up 38%. Even if the crude balloon pops, Energy stocks might not automatically follow suit. One reason could be the sector’s historically high dividends, with many of the larger Energy companies currently yielding well above the average S&P 500 yield of 1.3% and the of 1.45%. “Companies will probably have more cash to deploy,” Barron’s wrote in an analysis of the Energy sector over the weekend. It noted Exxon Mobil (NYSE:) has been able to cover its dividend from operating cash flow, and analysts are starting to forecast XOM could increase its dividend payout (but remember: Dividends are never guaranteed from quarter to quarter or year to year).
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