Equity markets continued their climb higher, with the S&P 500 Index gaining for the sixth-straight week for the first time in two years, finishing at a record high. Perhaps more interesting than the consistency of the gain is how investor sentiment has shifted. There are three distinct phases of sentiment gains. The first includes sentiment indicators and surveys, such as the CNN Fear & Greed Index, the AAII survey and the Goldman Sachs Risk Appetite Momentum Indicator. All of these have reversed sharply since August, perhaps to an unsustainable degree. The second phase (bearish Wall Street analysts capitulating) is showing signs of turning. The third would be a shift in investor behavior leading to equity fund flows. This could be the catalyst that drives a “blow-off top,” but will likely take some time.
A factor in the recent market strength is the growing belief that a trade deal with China is imminent, despite the continued mixed signals from both countries. This weekend was supposed to be the APEC conference where “phase one” was signed but was cancelled because of security concerns in Chile. There were reports of a “constructive,” high-level phone call over the weekend, driving Asian shares higher. The escalation of protests in Hong Kong could complicate things, as the Senate appears poised to sign a bill in support of the protestors. Markets have seen nearly two years of oscillation driven by trade uncertainty, and any hiccup could cause near-term volatility.
Retail sales slowed to 3.7% from a year ago from 4.5% last month on a core basis, with headline sales up only 3.1%. While sluggish, monthly retail sales are notoriously volatile, and the consumer appears to be in good shape heading into the holiday season. Retailers are nervous about the holiday season, with Black Friday falling a week closer to Christmas than in 2018. Research firm eMarketer estimates growth of 3.8% in the holiday season (up from 2.4% last year), crossing $1 trillion for the first time, with online spending up more than 13%, representing more than 13% of total shopping.
Trading in recent weeks has been undeniably “risk-on,” highlighted by strength in economically-sensitive areas like banks, manufacturers and energy companies. The preference for cyclicality teamed with rising interest rates have weakened the “bond-proxies” such as utilities, real estate and consumer staples. Fund managers have aggressively bought shares, bringing cash levels to six-year lows. Expectations for Fed rate cuts have moderated, with odds of a cut in December have fallen to 0% from 20% a month ago, with roughly a 50% chance for a cut by next June.
The spike in bond yields and steepening of the yield curve reversed last week despite the continued strength of the equity market. Historically, a cyclical shift in equities is paired with rising bond yields, though the technical factors (negative global rates, strong demand for yield) remain, likely decoupling the two until the technical factors ease. The repo market continues to show signs of stress despite assurances from the Fed that it is under control, with year-end repo rates at 3.25%, or 1.5% above today’s levels. Additionally, there are areas of the high-yield market that deserve attention, including spreads of the lower end of junk (CCC) and the shorting of high-yield ETFs.
What to Watch
This week’s economic releases include housing starts on Tuesday, leading indicators and existing home sales on Thursday and PMI and consumer sentiment data on Friday. The minutes from the recent FOMC meeting will be released on Wednesday.
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