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Financial Markets Updates

Monday, February 19th 2018 (Happy President’s Day Holiday!)

Stock prices rose sharply last week following the worst two weeks for the S&P 500 since August 2011. While all sectors advanced on the week and selling pressure receded, volatility still remains with the VIX or fear gauge, as represented by the iPath S&P 500 VIX Short-Term Futures™ ETN, symbol VXX, closing higher by about 1.5% on Friday. However, the VXX lost over 15% for the week and volatility has returned to the markets as noted in the following chart. With the unpresented low volatility of 2017, investors should adjust expectations for additional bouts of volatility in 2018 because the stock market has typically averaged three pullbacks of 5% every year.

For the week, the S&P 500 and the Dow indices both gained 4.3% and are now both higher by over 2% year-to-date. The recent 10% stock market correction has been cut in half with the S&P 500 Index ending the week down just 4.9% from its January 26th high. The prior week’s downturn was exacerbated by strategies betting on low volatility with the 250% spike in the VIX triggering trading algorithms to unload stocks. I believe the regulators should immediately halt the access of computer algorithms to the markets. Algorithms manipulate the market and create distortions that spook and cheat average investors. The selling pressure appears to have abated for now and all sectors rose last week with large capitalization technology stocks leading in performance. The Nasdaq-100 Index, which includes Apple (+10.3%), Netflix (+11.6%), and Amazon (+8.1%), rose 5.3% last week to outpace other major market indices.

Small capitalization value stocks rose 3.9% to modestly trail the Dow Jones Industrial Average and the S&P 500 indices. Since January 2017, the Nasdaq-100 has outperformed the Russell 2000 Value Index by roughly 35% and I anticipate this differential will contract over time because tax reform should disproportionately benefit smaller, domestically-focused companies. Data and analytics firm FactSet revised its estimate of fourth-quarter profit growth for the S&P 500 higher to 15.2% on a year-over-year basis and its best pace since late 2011. From a technical perspective, the move that we have witnessed over the last two weeks in the S&P 500’s trading range are not seen very often. In the span of two weeks, the S&P 500 has gone from an extreme overbought reading to an extreme oversold reading as of Friday February 9th. The median length for a 10% correction in the S&P since 1928 has been 64 days while this 10% dip occurred in 7 trading days. Last week’s rapid recovery in the major stock market indices is quite extraordinary and demonstrates the underlying strength of this bull stock market.

Source: Bespoke

The Trump administration released its infrastructure proposal last week which calls for $200 billion in federal spending to be combined with $1.3 trillion in state, local and private investment over the next ten years. The plan was met with skepticism from members of Congress, particularly as it would raise the federal deficit, rely on public-private partnerships, sell federal assets, and “streamline” environmental reviews. Lawmakers will now proceed with the sausage making process to mold the proposal into legislation as infrastructure spending has historically received bipartisan support.

Earnings and economic momentum remains very strong, and while inflation is rising and the Fed is hiking interest rates, both are occurring at a gradual pace. However, there are growing concerns about higher interest rates (coming out of a decade of 0% interest rates) and the exploding looming fiscal deficits, adding upward pressure to interest rates which are real concerns that we are monitoring very closely. I believe for now that from a fundamental perspective, these concerns are not enough to derail this bull stock market considering the growing global economic momentum and the positive outlook for corporate America. Historically, recessions end bull stock markets and these issues are not close to causing a recession. I do not think we are out of the woods yet, but the good news is that last week’s stock market rebound demonstrated more constructive fundamental behavior that I think will keep the broader bull stock market intact a while longer.

On the economic front, "Feeling hot hot hot." The Merrymen. Inflation and Housing Starts heated up in January, but Retail Sales were on the chilly side.

January Housing Starts jumped 9.7 percent from December to an annual rate of 1.326 million units, above expectations, as per the Commerce Department. This was the highest level since October 2016 and up 7.3 percent from January 2017. Single-family starts, which account for the largest share of the market, rose 3.7 percent from December and are up 7.6 percent from January 2017. Multi-dwelling starts, which include five or more units, surged 19.7 percent from December. Housing Starts rose in the Northeast, South and West but declined in the Midwest.

Building Permits, a sign of future construction, rose 7.4 percent from December to an annual rate of 1.396 million units. The strong report could be a welcome sign for buyers struggling with low inventory around much of the country. Consumer inflation also edged higher in January, with a key component spiking to a 12-month high! The Consumer Price Index (CPI) rose 0.5 percent in January, just above expectations due to higher gasoline prices, the Labor Department reported. The more closely watched Core CPI, which strips out volatile food and energy prices, rose 0.3 percent from December. This was the largest increase in a year, boosted by rising rents.

When you see these Bond prices moving higher, it means home loan rates are improving. When Bond prices are moving lower, home loan rates are getting worse. To go one step further, a red "candle" means that MBS worsened during the day, while a green "candle" means MBS improved during the day. As you can see in the chart below, Mortgage Bond prices have been trying to stabilize after their recent plunge. Home loan rates have risen, but remain historically attractive.

Chart: Fannie Mae 4% Bond Friday February 16, 2018

U.S. Dollar - It was a lousy week of trading for the dollar as represented by the PowerShares DB US Dollar Bullish Fund ( symbol UUP) losing 1.4% last week. The Greenback has essentially reversed its recovery from the previous two trading weeks, to return back toward levels not seen since December 2014. The dollar has not been valued this low since traders began to price in the normalization of U.S. interest rate policy from the Federal Reserve that began in 2015. Considering that expectations are high for the Federal Reserve to raise U.S. interest rates multiple times this year, the U.S. interest rate policy is no longer a major factor for investors to purchase the U.S. dollar. Investors are instead focusing on the development of economies that are being influenced by other Central Banks. For example, news last week that European Union economic growth had printed its best performance since the 2007 global financial crisis began to unfold and reiterated the ever-increasing optimism over the global economy. The distance in economic recovery between the United States and other developed economies has been narrowing for some time and it has now come to the attention of traders that it is only a matter of time before other major Central Banks prepare the financial markets for their own adjustments to increasing interest rates.

This eventuality poses a significant risk of weakening investor attraction toward the dollar from growing U.S. debt loads. It will also play a pivotal role towards the U.S dollar being at risk of hitting further multi-year lows over the months to come, and it is still possible that the Dollar Index will extend its decline to 85 over the current quarter. This would further extend the advancements in major currencies that have already strengthened by approximately 4% year-to-date. Such a move would risk the Euro trading around 1.27 for the first time since approximately October 2014 and would further accelerate the strength in the Japanese yen that has already climbed this year versus the dollar. The Dollar Index has again reached a massive area of support around 88.50. This level was major resistance back in the years 2008, 2009, 2010 and 2014, before the dollar lift-off late in 2014. I want to remind everyone that a weaker dollar makes U.S. corporate products on foreign shelves more affordable and, hence, rising U.S. stock prices.


GOLD - The key to a sustainable gold rally is a moderation in the rise in interest rates, but a continued acceleration in inflation, which would result in declining real interest rates is a favorable dynamic for gold. The CPI and Core CPI headlines were hot last week, but the 30-year bond yield only rose slightly. Accordingly, we are entering a phase where inflation expectations are beginning to outpace the rise in interest rates, or simply put, real interest rates are beginning to fall. If this market dynamic of falling real interest rates continues, a sustainable uptrend will develop in gold. On the chart, gold remains just shy of resistance at $1360, but the trend over the last two months has been very bullish with gains of over $100 an ounce trough to peak. Look for a close above $1360 on high volume to mark the start of a new uptrend in gold.

COPPER - Copper traded higher last week with the iPath Dow Jones-UBS Copper Total Return Sub-Index ETN (symbol JJC) rising 6.8% for the week. Strong price action in copper is reassuring after a bout of stock market volatility, as it underscores the strong fundamental outlook for the global economy and risk assets in general.

OIL - Production was the big focus last week, as U.S. output had spiked triple digits multiple times so far in 2018, raising concerns that domestic production may be accelerating much faster than previously expected and a clear fundamental headwind for energy prices over the longer term. However, oil managed to regain some of last two week’s loses and rose over 4% last week and the longer-term trend in the oil market remains bullish. However, the significant increase in U.S. oil output noted in the following chart could derail that rally if the pace of weekly production increases does not moderate further, or if doubts arise about the health of global economic growth.

In overseas markets, European stocks ended last week higher, with most major indexes showing strength in a variety of sectors as concerns about rising interest rates and inflation eased. The pan-European STOXX 600 index could not recover the steep losses it logged from the prior week, but investor appetite for European shares was nevertheless robust, as the STOXX 600 index rose around 3% for the week. Blue chip indexes, including Germany’s DAX 30 and the UK’s FTSE 100, also strengthened. The euro strengthened versus the U.S. dollar and a strong euro versus other countries depresses revenue for European companies that sell their goods in overseas markets. With corporate earnings reports in full swing, most companies were topping earnings estimates. 54% of companies listed on the STOXX 600 have beaten estimates, and earnings to date had grown about 17% compared with the first quarter of 2017.

JAPAN - The large-cap Japanese stock indexes moved higher last week. The Nikkei 225 Stock Average gained 1.6% for the week. However, year-to-date, all the major Japanese market indexes remained underwater: The Nikkei was down 4.6%, the broader TOPIX Index was off 4.4%, and the TOPIX Small Index had declined 6.4%. The yen continued to strengthen and closed Friday’s trading at ¥106.2 per U.S. dollar.

CHINA - Chinese stocks advanced in a holiday-shortened week, paring some of their big declines from the previous week’s global stock market sell-off, as the country prepared for the Lunar New Year holiday. Each year, China’s economy grinds to a halt during the week-long holiday, the country’s most important annual ritual. Chinese mainland markets are closed from February 15 to February 21 this year and trading was muted in the days before the holiday’s official start.

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Information contained herein is obtained from industry sources believed to be reliable. The information presented comes from different sources on a weekly basis and is intended to provide a commentary related to market events and is not intended to be used as investment advice or represent any specific product or service. Market information and performance information is provided from different industry sources including, but not limited to TD Ameritrade; MMG; Barron’s; BBC; NPR; Reuters; MFS Research; CNBC; CME; The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes; CNNMoney; J.D. Power Valuation Services; The Economic Times; USA Today; stockcharts; CotSignals; Bespoke; Manheim; FreeStockCharts; The Fed; LPL Research; FactSet; Econoday; U.S Bureau of Economic Analysis; Hulbert Ratings; World Development Indicators database from the World Bank and the Internet.