As I indicated in the conclusion of last week’s note, equity markets were vulnerable to further weakness based primarily on February’s selloff and the technical setup provided in the previous week. I also suggested that the bias was lower and that equity markets would remain in a “holding pattern” at least until after the FOMC meeting and Fed Chairman Jerome Powell’s press conference. Though the week did start off with a degree of volatility, it was not until after the press conference that the institutional selling materialized in force. Not only did we witness a sharp pullback on escalating volume on all major equity exchanges on the week, but also the S&P 500 (^GSPC, SPY) closed exactly 10% off its record high while simultaneously setting up investors for that retest of the February lows the we have been expecting.
It was an eventful week both politically and economically. Not only had President Trump followed through with his well-telegraphed intentions in regard to steel and aluminum tariffs, but China also retaliated by threatening tariffs on American agricultural products. Additionally, national security advisor H.R. McMaster resigned from the administration, setting off alarms in diplomatic circles around the world. The announcement that John Bolton, former U.N. ambassador, was his replacement only added to the consternation. As if that weren’t enough, Trump signed the largest omnibus bill in US history and, in the process, managed to achieve few if any of the promises he campaigned on.
As expected, the Federal Reserve raised interest rates by a quarter point last Wednesday. The FOMC increased the overnight funds rate to 1.5% to 1.75%. The rate steering committee kept the projected number of rate increases to three for this year. All of that was expected by the Street. What was not expected was the revised upward expectations for additional rate moves in both 2019 and 2020. It was almost as if the three raises that had been priced into the market were undercut by the fact that a fourth move in rates is not off the table. Markets immediately turned lower on that subtlety on Wednesday and gave back all of the prior session’s meager gains. Powell’s press conference, following the FOMC meeting and announcement, provided investors with little to counterbalance the sense that the FOMC is more inclined to tighten than not, and sooner than later.
It was a very Fed-centric week, but there were other economic variables at play as well. Existing home sales data for February was released on Wednesday morning. For the month, sales rose modestly to an annualized rate of 5.540 M from the prior month’s disappointing reading of 5.380 M. Bloomberg consensus had been calling for 5.420 M. On a year-over-year basis, existing home sales are tracking a gain of 1.1%. WTI Crude received a bid in part as a result of the EIA Petroleum Status Report for the week ending March 16. There was a draw in all three verticals. Crude inventories dropped 2.6 M barrels, gasoline dropped 1.7 M barrels and distillates dropped 2.0 M barrels. Significant lift for crude was also provided by the Baker-Hughes Rig Count totals for the week. They came in at 1,156 versus the previous week’s 1,209. Once again, Canadian rig counts shrank as a result of weather-related issues as they had the previous week. It is very likely that rig counts will jump in coming weeks and as a result provide some headwinds for crude.
The FHFA House Price Index for January was 0.8% versus December’s revised 0.4%. Weekly jobless claims for the week ending March 17 were a strong 229K. Leading Indicators for February were 0.6% – well above Bloomberg consensus of 0.3%. Finally, new home sales for February were 618K, in line with consensus calling for 620K.
Economy strong, markets unsure
All of this underscores my sense that the economy is firing on all cylinders. Inflation has not accelerated in a meaningful way that would warrant undue alarm and Q4 results from US corporations were solid. US equity markets, on the other hand, have been anything but solid in recent weeks. The first cracks in the momentum trade higher surfaced in early February as a result of investors overeating to inflation data. We have since seen markets struggle to find equilibrium. Last week’s meltdown only added to the panic as the volatility index (^VIX, VXX) moved dramatically higher once again.
If equity price trend is in part dependent on the broader economic landscape, we are on solid ground. Interest rates are at historically low levels, GDP is expanding, employment gains have been consistently solid, manufacturing has witnessed a rebirth, confindance—both consumer and business—are at multi-year highs. Additionally, corporate earnings and revenue growth remained positive through Q4 of 2017.
We wrap up Q1 this week with a decidedly negative tone in equity markets and a retest of the 200 DMA. Investor sentiment is also quite negative. The next directional cue that investors will be focusing on will be Q1 earnings. As mentioned last week, Standard and Poor’s raised its one-year guidance for the S&P 500 to 3000. They also raised targets for EPS and revenue growth. Q1 earnings season begins the first week of April. If, as I believe will be the case, Q1 results in aggregate are 65% to 70% above consensus estimates, we will see both stability and further gains in equity prices in the early going in Q2. In the near term, the test this week will be for the S&P 500 to hold the aforementioned 200 DMA. It’s a week free of corporate earnings and, as a result, this leaves U.S. equities vulnerable. I remain cautious this week but expect equity markets to catch a bid at the outset of earnings season and in the process allow investors to escape a bear market. The wildcard is President Trump.