No Punch for You

By Pete Biebel, Senior Vice President

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If there was a message in the first day of trading last week, it was that the market is not too concerned about the rising omicron numbers. The New Year began with a new high for both the Dow Jones Industrial Average (DJIA) and the S&P 500 Index (SPX). The new highs were not much beyond the old highs, but new records nevertheless. The “reopening” stocks of airlines, cruise lines and hotel companies were conspicuous big winners on that first day of trading. Unfortunately, the second through fifth trading days of the year didn’t go quite as well.

If there was a message in the second day of trading it was that steeply rising interest rates can still be a concern for the stock market. The yield on 10-Year Treasury notes stood at 1.51% on New Year’s Eve. That yield climbed to 1.62% on Monday and hit 1.68% Tuesday morning. Below I’ll describe how the higher rates affected various sectors. DJIA and SPX both hit even higher intraday highs Tuesday morning, though SPX failed to hold the early gains. Several of the Dow component stocks posted fat gains that day helping DJIA reach another record closing high. Whereas DJIA ended the day with a 0.6% gain, the NASDAQ Composite Index (COMP) lost 1.3%. The losses in the big-tech stocks that pulled down COMP also weighed on SPX, which ended the sessions with a small net loss.

Many believe the message in the market on Wednesday was that stocks had overestimated the time frame in which the Fed would end its program of monthly liquidity injections and be in a position to increase its short-term lending rate. Not only did it seem that the Fed would no longer be filling the never-empty punch bowl that has been hydrating stock prices for years, but also that the Fed might actually begin draining the bowl far sooner than had been expected. Shortly after the release of the minutes from the Fed’s December meeting, the 10-Year yield spiked to 1.71% and stocks headed south. DJIA lost 1.1% that day while SPX fell 1.9% and COMP sank 3.3%. I’m sensing a pattern here.

In reality, there wasn’t any real new news in the minutes with respect to the Fed’s timing. If anything, the revelation in the minutes was that there didn’t seem to be any bias against raising rates. Shortly after the release of the minutes, the odds of a rate hike in March, as implied by the Fed Fund futures market, jumped to more than 75% from about 50%.

There were two other important aspects of the market action that afternoon that contributed to the violence of the decline. One was the acceleration in selling that came when COMP and SPX dropped through key technical levels. After SPX took out its Monday low in the early afternoon on Wednesday, it suffered a nearly uninterrupted decline until finding support at its 50-day moving average. Friday’s close at 4677 is less than three points above that average.

Another factor was the impact the prospect for higher interest rates had on the valuation of high-growth stocks and mega-cap tech stocks in particular. In recent months, I have documented the narrowing of market breadth and cautioned that it could be a bad omen for the market in the months ahead. In December, in my article “No Soup for You,” I detailed how a relative handful of mega-cap tech stocks had accounted for an overwhelming portion of market gains for the year. Those stocks “have consumed more than their fair share of the points gained in the index, leaving, if anything, mere scraps for the majority of stocks.” Clearly the concern was that if/when those leaders began to underperform, it could be bad news for the overall market.

The weakness in the big tech stocks continued through Thursday and Friday. The major indices all traded below Wednesday’s low on Thursday, and below Thursday’s low on Friday. For the week, COMP was down a bit more than 4.5%; SPX lost nearly 2%. DJIA, thanks to its early-week strength, snuck through the week with a mere 0.29% loss.

The 10-Year rate continued to climb through the week, eventually touching 1.80% Friday morning and ending the week near 1.77%. The size and speed of the increase in interest rates was probably more significant than the actual interest rate level. Where the spike in rates triggered a rush out of high-growth stocks, it also increased the attractiveness of bank stocks.

Because the profitability of banks improves when longer-term interest rates widen their edge over short-term rates, traders gobbled up bank stocks last week. Bank stocks account for about 50% of the weight in the S&P Financials Sector Index. In a week in which most of the major averages had significant losses, that index gained about 5.5%.  The NASDAQ/ABA index of community bank stocks was even stronger; it rose about 6.6% for the week.

Another bright spot in a relatively dark week was the Energy sector. Crude oil prices rallied about 6% from Monday into their high Friday morning. And prices of near-by natural gas futures have gained about 10% in the past week-and-a-half. The climbing commodity prices sparked an across-the-board rally in the Energy sector. Every stock in the S&P Energy Sector Index had a gain for the week; two-thirds of the stocks in the sector had double-digit percentage gains last week. Energy led all 10 of the other S&P industry sectors in 2021 with about a 46% gain for the year. It started off 2022 in the lead again, racking up a 10.5% gain last week.

If there was an overall message in the market action last week, it might be that we shouldn’t expect significantly higher highs any time soon. Any rebound attempt early this week in SPX is unlikely to even get back to last Monday’s lows near the 4760 level. The first objective for the bulls will be to avoid significant additional losses that would force SPX to sustained trading below its 50-day moving average. Unfortunately, in its current vulnerable state, a little more bad news could go a long way. My guess is that if SPX takes out the 4640 level, it would be likely to have a further decline in the 4500 area. COMP is already well below its 50-day average and is now less than 2% above its 200-day average. That 200-day average is currently in the 14,682 area and will represent a critical level for that index.

Any drama arising out of news releases will likely be later in the week. Wednesday brings the report for December CPI and the Fed Beige Book. The PPI and Initial Claims reports will follow on Thursday. In addition to the Retail Sales numbers on Friday, we’ll get the first of the significant announcements in a brand-new earnings season. Several big banks are scheduled to announce their quarterly results that day.

Date Report Previous Consensus
Monday 1/10/2022 Wholesale Inventories, November, M/M

+2.3%

+1.2%

Tuesday 1/11/2022 NFIB Small Business Optimism Index, December

98.4

98.8

Wednesday 1/12/2022 Consumer Price Index, December, M/M

+0.8%

+0.4%

CPI, December, Y/Y

+6.8%

+7.1%

CPI, ex- Food & Energy, December, M/M

+0.5%

+0.5%

FOMC Beige Book
Thursday 1/13/2022 Initial Jobless Claims

207K

205K

Producer Price Index, December, M/M

+0.8%

+0.4%

PPI, December, Y/Y

+9.6%

+9.8%

PPI, ex- Food & Energy, December, M/M

+0.7%

+0.5%

Friday 1/14/2022 Retail Sales, December, M/M

+0.3%

0.0%

Retail Sales, ex-Vehicles & Gas, December, M/M

+0.2%

+0.2%

Industrial Production, December, M/M

+0.5%

+0.3%

Business Inventories, November, M/M

+1.2%

+1.1%

Consumer Sentiment, January

70.6

70.4

 

Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.