Stock Investors - Slight Selloff On Friday
The optimism about the trade war is way overdone. New tariffs make it more likely there will be an economic slowdown in late 2018 and early 2019.
The stock market is also way overbought even after the mild decline on Friday. The Dow was the only index that was up as it increased 0.32% to a new record. The S&P 500 fell 4 basis points, the Nasdaq fell 0.51%, and the Russell 2000 fell 0.46%.
As the action in the first week of September stops being included in the 14 day RSI, it will go up sharply. That is, if stocks don’t fall.
As you can see from the chart below, the 14 day RSI is 69.6 which is just 0.4 away from being overbought. If stocks are even slightly positive next week, it will surpass the August high.
Even though the S&P 500 fell slightly, the CNN Fear and Greed index hit 75 which is extreme greed. I’m very bearish on stocks in the near term. They have run too much and the tariffs are being ignored.
Twitter and Micron were among the biggest losers in the S&P 500 as they fell 4.5% and 2.9%. The biggest winners were IPG Photonics and American Airlines which rose 4.2% and 4.1%.
The best sectors were energy and telecom as they increased 0.72% and 0.98%. Tech and financials were the worst hit as they fell 0.34% and 0.36%. This is the last day tech will have its current makeup and it’s the last day the telecom sector will exist.
While the financials aren’t at their January high, they have increased 9.03% from June 27th. I was correct in saying the financials needed to power the market higher.
Stock Investors - Positive Real Yields Coming Soon
Just like the market, the 10 year yield was flat at 3.06%. The yield peaked at 3.08% in the morning as it is trying to reach its cycle high, but has been failing recently. It will be a big technical break out for it to get above 3.11% just like it was a big deal for the S&P 500 to hit a new record high in August.
The 2 year yield was flat at 2.8% which means the difference between the two yields is still 26 basis points. The Fed’s September meeting where it has a 100% chance of raising rates will occur on Wednesday.
The Fed fund futures market has recently become so hawkish that there’s a 6.2% chance there will be two hikes next week. That’s impossible in my opinion.
If it does occur, the stock market will sell off in shock. After the one hawkish hike, I expect stocks to rally modestly because the rate hikes are going smoothly.
To be clear, that’s in reaction to the Fed. Other than that reaction on Wednesday, I’m bearish. There is now an 85.7% chance of at least 2 more hikes in 2018 and a 7.3% chance of at least 3 more hikes.
As you can see from the chart above, the Fed funds rate minus the core CPI is about to go positive this year as there will be 50 basis points in hikes.
It will only stay negative if the core CPI jumps more than 20 basis points from the current rate. There needs to be 7 more hikes to get to the historical median.
According to LPL Research, recessions haven’t historically started until the real Fed funds rate hits 2%.
Stock Investors - No recession has ever started with a negative real Fed funds rate.
Since the real Fed funds rate is about to be positive, that streak without a recession will continue. It’s debatable if we should use core CPI or headline CPI to measure real rates.
Either way, I think it’s fair to say that once the Fed funds rate gets above core CPI, policy is no longer accommodative. The Fed removing that term from its statement at either the September or December meeting will be big news.
One final point I’ll make about next week’s meeting is that if the Fed raises rates once, the 2 year yield could fall slightly. There’s a small chance the Fed raises rates twice and one hike is already priced in.
Since there will likely be two more hikes this year, the futures tell me the 2 year yield shouldn’t increase much. They are almost completely priced in.
However, it's good to start following the 2019 Fed fund futures market after the September meeting. Guidance on 2019 policy will affect the 2 year yield.
Stock Investors - Q3 GDP Growth Estimates
I always like to check the GDP forecasts because they provide a great summary of the rate of change in economic data. However, the early predictions are often way off.
We are now deep enough into the quarter that the forecasts are somewhat accurate. The CNBC GDP tracker which reviews 13 estimates has an average growth rate of 3.4% and a median growth rate of 3.3%.
Since the ECRI leading index is up 0.2% year over year and has been decelerating since February, as you can see from the chart below, growth above 3% is a big victory.
Also, keep in mind that the year over year comparisons in the ECRI index will be very easy in September, but they will get more difficult by the end of the year.
The Atlanta Fed GDP Now estimate is at 4.4% which is very optimistic compared to the other estimates I’ve analyzed. On Wednesday September 19th, the Nowcast was unchanged.
The new residential construction report caused the estimate for real residential investment growth to improve from -0.7% to -0.2%. I think it would be amazing to see a decline in real residential investments with GDP growth above 4%.
The St. Louis Fed Nowcast expects growth of 4.37% which is almost exactly the same as the Atlanta Fed.
The NY Fed Nowcast is very pessimistic as it has been in the past few quarters. It moved its estimate from 2.24% growth to 2.26% growth. Building permits hurt the estimate by 9 basis points and the housing starts helped it by 12 basis points.
The Q4 estimate is for 2.66% growth as it fell from 2.75%. The difference here is the Empire Fed index hurt it by 10 basis points.
Recent Comments