A Washout Trade and Rising Risks

The breakdown in equity market pricing last week was more follow-through from the previous week’s performance than it was an event in and of itself. As discussed in last week’s note, several drivers have contributed to the sharp pullback we have witnessed. Among those themes, two stand out:

  • Ongoing concerns over the current and future status of US/China trade negotiations, fueled by clear indications that both sides are increasingly adopting more punitive trade postures and flirting with currency devaluations
  • Frustration on the street with the Fed’s outlook on the economy––one that does not appear to indicate a cycle-end on the immediate horizon

As we open for trading this week, both themes remain front and center for investors. As a result, and given the sell-off that materialized last week, it is safe to say that any meaningful intraday gains in equity markets this week will likely be met with resistance. With that as a backdrop, I also feel the likelihood of another leg-down in prices this week is not high.

It is interesting to see that after Monday’s sharp sell-off, all major US equity indices attempted to rally. Though all three indices lost ground on the week, they nearly recovered all of the one-day losses that were registered in Monday’s trouncing. However, Friday’s price action was telling; Markets lost marginal ground across the board but, more interestingly, none were able to add to Thursday’s gains. The post-Monday rally lost steam. That is, in part, a result of it being the last trading day of the week during a period of heightened volatility.

It also a function of the fact that equity markets all closed out the week not far from their respective fifty-two week highs. The Dow and S&P 500 closed 4% below their record highs and for all the headline risk associated with many of the largest cap names on the Nasdaq, the Nasdaq composite only closed 5% off its record high. In short, though markets took investors for a ride last week, as expected, and though we did retest the 200 DMA on the Dow, we remain in very good shape on a year-to-date basis.

  • Dow Industrials: +12.69%
  • S&P 500: + 16.43%
  • Nasdaq Composite: 19.95%

Given the expanded volume and intensely negative Advance/Decline (A/D) profiles in the sell-off that materialized over the past two weeks, it is important to keep in mind that we still stand with very significant YTD gains across all three equity market indices. Those YTD gains were largely fueled by anticipation of the first Fed easing since the financial crisis and expectations for progress in trade talks. The street received neither in full. Yes, the Fed cut 25 bps, but the balance of the FOMC narrative left the street disappointed.

Other factors that have provided a degree of lift for US equities in recent months include Q2 earnings, and a steady, though uneven, stream of economic data that reflects net expansion. Broadly speaking, better than expected employment data, wage growth, personal income and spending, and below-target inflation are factors that fall into that vertical.

More specifically, last week’s economic data releases remained in-channel. The ISM Non-Mfg Index reading for July, for example, released Monday, was 53.7. Though a tick lower than June’s 55.1 reading, it remains in expansion mode. The EIA Petroleum Status Report, released Wednesday, reflected inventory builds across all three verticals. Crude inventories rose 2.4M bbl. Gasoline inventories rose 4.4M bbl. Distillate inventories rose 1.5M bbl. Demand has remained strong and, though there are heightened tensions in the middle east––and Straits of Hormuz specifically––energy prices have remained tame here in the US.

Weekly jobless claims, released Thursday morning, continue to provide a narrative that flies in the face of those calling for an impending economic contraction, while simultaneously providing the Fed with a degree of ammunition to be quite deliberate with regard to any additional loosening. For the week ending 8/3, claims came in at 209k––below Econoday consensus of 215k. The 4-week MA – level stands at a healthy 212k.

The Producer Price Index – Final Demand (PPI-FD) for July was released on Friday morning. The results were hardly surprising. The M/M change was 0.2%, meeting Econoday consensus and 0.1 above June’s reading. Y/Y results matched both June’s and Econoday consensus at 1.7%. Less food and energy, Y/Y came in at 2.1%, well below consensus of 2.4%. Clearly, inflation is not a factor at the producer level. Additionally, fears of inflationary pressures being brought to bear as a result of the trade tariffs on Chinese imports have not materialized.

US equity markets remain mired in late summer volatility.

Our recent highs are likely to remain intact for the foreseeable future, as mounting concerns over global growth, trade, and a continuing stream of reduced earnings expectations all wear on investors’ nerves. Further, to the degree to which we see indications of continued healthy economic expansion, odds of additional monetary policy loosening lessen. Recent volume profiles that have accompanied our down days have highlighted the obvious––institutional investors have been taking some chips off the table.
This Week’s Economic Data Highlights:

The Consumer Price Index (CPI) for July is released at 8:30 am. Econoday M/M consensus is 0.2%, up from June’s 0.1%. Y/Y consensus is 1.7%.

The Energy Information Administration (EIA) Status report is due out at 10:30 am. As touched upon above, last week’s report reflected modest inventory builds across all three verticals.

-Weekly Jobless Claims are due out at 8:30 am. Also as mentioned above, this is a data point that has remained stubbornly constructive – much to the chagrin of those hoping for addition Fed loosening.
-The Philadelphia Fed Business Outlook Survey is out at 8:30 am. General Market conditions last month were 21.8. August’s survey results are expected to weaken, 11.1.
-Retail Sales for July are out at 8:30 am as well. This month’s results should dovetail with the healthy personal income data that were received the week of July 29. Econoday is calling for a M/M reading of 0.3%, less autos, 0.4%. The control group M/M is expected to weaken from 0.7% to 0.3%.
-The Fed’s monthly Industrial Production release is due out at 9:15 am. Production is expected to come in marginally ahead of June’s flat reading (0.1% versus 0.0%). Manufacturing M/M is expected to contract by 0.1%. Capacity Utilization will remain strong. Econoday is calling for a reading of 77.8%.

Housing Starts for July are released at 8:30 am. Starts – Level – SAAR for June were 1.253M. Permits were 1.220 M. This month’s reading is expected to remain in-line. Econoday is calling for 1.260M and 1,270M respectively.


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Flickr photo: by stëve