By Pete Biebel, Senior Vice President, Senior Investment Strategist
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In the previous week, stock indices were on cloud nine and soaking up the sun in the three days following Election Day. The major averages hit new all-time highs. Life is good! The motivation behind that rally was the expectation for fair weather in the years ahead in an era of faster economic growth with greatly reduced regulation and tax cuts under the new administration. Unfortunately, something resembling a thunderstorm blew in and soaked the market last week. The week began with a small gain early on Monday. The S&P 500 Index (SPX) even managed to close slightly above the 6,000 level for the first time. But a cold front of less-than-favorable news caused the averages to all lose ground pretty steadily over the next four sessions.
The most damaging of that news was the president elect’s contentious picks for several key cabinet positions. There was concern that drawn-out confirmation hearings would delay implementation of the promised economic and fiscal initiatives. There was also new apprehension that by selecting three House Republicans, the choices could ultimately reduce – if not eliminate – the narrow Republican majority in the House of Representatives. We also learned that the 12-month core Consumer Price Index is still hanging around 3.3%, well above the U.S. Federal Reserve Board (Fed) target. And the Fed chairman himself, Jerome Powell, hinted on Thursday that his committee might take a rain check on anther successive rate cut. He stated that the Fed is in no hurry to further reduce its fed funds target interest rate. The comment precipitated more doubt about a December Fed rate cut. Last month, the probability of a rate cut at the December meeting was a 90% near certainty. The market now puts those odds at closer to 60/40 in favor of a cut.
SPX hit a new high Monday morning but ended the week with just over a 2% loss. The NASDAQ Composite Index (COMP) also recorded a new high on Veterans’ Day before skidding to a 3.15% loss for the week. (Both indices left what technicians call a six-day island top, a potentially bearish omen. The averages gapped higher on the opening on November 6, then gapped down last Thursday.) The weather wasn’t much better for the Dow Jones Industrial Average (DJIA). It too hit a new high Monday but ended the week down 1.24%. After stealing the thunder of its large-cap peers in the prior week, the Russell 2000 Index of small-cap stocks (RUT) was a little under the weather last week. RUT gained a whopping 9% in election week only to give back about half that increase last week.
Because the potential for reduced regulation of financial companies is a real possibility, that sector was again among the best performers with a net gain for the week of more than 1%. Financials were the best of the 11 S&P industry sectors last week, and have the second-best gain over the past five weeks. The political trade winds also had a big (and much more negative) impact on the healthcare sector. The announcement that Robert Kennedy Jr. was to be the new head of Health and Human Services sent a shiver through biotechnology and pharmaceutical stocks. The S&P Health Care sector lost 5% last week, the S&P 500 Pharmaceuticals Industry index fell nearly 6% and the S&P 500 Biotechnology Industry index fell more than 13%.
Over the past several months, I have written that the threat of higher-for-longer interest rates is a risk to stock valuations that is lurking in the distance, like a shelf cloud. In my last two articles I wrote, “The prevailing assumption is that lower short-term rates will automatically lead to lower long-term rates.” Just watch the local or national news on Fed-day. You’ll hear things like, “The Fed chose to not lower interest rates today,” or “The Fed cut interest rates today.” It’s always “rates” plural. Everyone is watching the Fed because everyone believes that a lower fed funds rate will result in lower long-term interest rates. In one article on Friday, a major financial news outlet included the following three lines: “Separately, a Federal Reserve official said it was too soon to say whether the central bank should cut interest rates at its meeting next month.” “In the previous week, stocks rose to new highs after Donald Trump won the presidential election and the Federal Reserve cut rates by a quarter point.” “The latest moves highlighted investor uncertainty about whether the Fed is in a position to continue cutting rates as much as markets have come to expect—in part because the economy continues to hold up well.” Again, “rates” plural.
The fact is that the Fed controls only the fed funds target rate, which is an overnight lending rate for interbank loans. While the level of that rate has some influence over very short-term interest rates, it is much less closely correlated with long-term rates. Before 2009, in an era characterized by scarce reserves, that rate meant something. The Fed could control the looseness or tightness of liquidity within the banking system. But since then, through the years of “zero interest rate policy,” reserves for banks have been anything but scarce. Banks are awash with liquidity. There’s very little need for them to shore up reserves by borrowing in the overnight market. Years ago, the Fed had some ability to influence economic activity by raising or lowering the fed funds target rate. Now, changes in that rate have very little impact on our economy.
When the Fed lowered its target rate by one-half percent, 10-year Treasury notes were yielding a bit over 3.6%. Now, just two months later, and with an additional quarter-point cut on November 7, the 10-year yield is around 4.4%. The bond market seems to be growing more worried about the potential for rekindling inflation and/or stronger economic activity along with the country’s massive debt and expanding deficits. In my sector commentary to our advisors last week, I wrote, “The next couple weeks should tell us a lot about the near-term trend in the 10-year rate. Below you’ll see that the increase has lifted the yield to the top rail of a year-long downtrend channel. It’s not surprising that yields would slip back a bit from that range. But will the slide continue to below 4.0%? Or will the yield climb above and beyond the 4.5% level? I expect the latter is a much more likely outcome. If that yield does rise above 4.5% in the weeks ahead, I think that would signal that even higher yields are likely. I expect the stock market would no longer be able to turn a blind eye on the bond market.”
The markets seem to expect that the new administration will introduce tax cuts, tariffs and regulatory easing. Whether whatever changes are eventually enacted have a net positive impact on earnings and asset prices will only be known many months from now. But current values already have priced in a very optimistic outcome. At its current value, SPX stands at 22.2 times its expected next 12-months earnings. The only other times the index has been that expensive were in 1999 and 2021. Recall that the following years were stormy ones for stocks. In another measure of relative value, SPX’s dividend yield is down to 1.27%. It hasn’t been that low in nearly 24 years.
SPX ended the week near 5871, in the area of its October highs. Even though the index is above the price levels of a month or two ago, the set-up now seems much more bearish. True, if a rebound is attempted this week, the index should have very little resistance in climbing through the vacuum created by last week’s downdraft to retrace at least a portion of the recent loss. A rally should be a breeze. But the lack of a rebound attempt or an attempt that fizzles soon after it begins would have the bears licking their chops. Falling much below the mid-5800s would be the technician’s equivalent to a sailor’s “red sky in morning.” Falling below the October low near 5700 would pretty much confirm that the market had just seen a blow-off, bull-trap intermediate-term top.
There’s not much on the economic reports or earnings announcements radar this week that is likely to roil the markets. The one blip that will almost surely have an impact is the Wednesday afternoon earnings announcement from NVDIA Corp. The most-watched news of the week will be of the political variety. Come rain or shine, keep an eye on that 10-year yield.
| Economic Calendar (11/18/24 – 11/22/24) |
Previous |
Consensus |
|
| Monday 11/18/2024 | Home Builder Confidence Index, November |
43 |
42 |
| Tuesday 11/19/2024 | Housing Starts, October, SAAR |
1.35mm |
1.34mm |
| Building Permits, October, SAAR |
1.43mm |
1.44mm |
|
| Wednesday 11/20/2024 | No Reports Scheduled |
|
|
| Thursday 11/21/2024 | Initial Jobless Claims |
217K |
220K |
| Continuing Claims |
|
||
| Philadelphia Fed Manufacturing Survey |
10.3 |
6.0 |
|
| Existing Home Sales, October, SAAR |
3.84mm |
3.91mm |
|
| Leading Economic Indicators, October, M/M |
-0.5% |
-0.4% |
|
| Friday 11/22/2024 | Flash Services PMI, November |
54.1 |
|
| Flash Manufacturing PMI, November |
48.5 |
48.8 |
|
| Consumer Sentiment, November |
73.0 |
73.5 |
|
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Market Commentary/Market