S&P 500

S&P 500 Rally Continues Despite Bond Market Signaling Fed Rate Hike Cycle Could End Up Badly

Ed Wijaranakula, Ph.D.
Fri Mar 3, 2017

The S&P 500 gained another 0.67% for the week, to close on Friday at 2,383.12, up for the sixth straight week. The index is now trading at the top of the ascending channel and volatility could increase as the market moves higher. The best performing S&P 500 sectors for the week were Financials ($SPF) and Energy ($SPEN), up 2.02% and 1.44%, respectively. 

Traders ran up the Financials and Energy sectors over euphoria of President Trump’s first speech to Congress on Tuesday night. The Financials sector is trading at the top of the range and may pull back if the yield spread continues to narrow. The worst performing sector for the week was Telecommunication services ($SPTS), down another 1.13%, as investors rotated out of high-dividend yielding stocks like Verizon (NYSE:VZ) and AT&T (NYSE:T).

President Trump’s speech was a non-event due lack of specific details on tax policy, economic policy and infrastructure spending. The U.S. Dollar index (DXY), essentially the USD/EUR exchange rate, retested 102.16, or the 61.8% Fibonacci retracement level, on Thursday, before pulling back to close on Friday at 101.38, up 0.29% for the week, despite that New York Fed President William Dudley said on Wednesday that the case for raising U.S. interest rates has become "a lot more compelling" since the November election, given rising confidence and expectations for fiscal stimulus.

In fact, Trump’s “Phenomenal” Tax Bill could be pushed back until August, while President Trump and GOP leaders are reportedly considering punting on a major infrastructure package until 2018, as Congress wrestles with a crammed legislative calendar this year, according to The Hill.

The Federal Reserve Bank of Atlanta revised its U.S. first quarter GDP 2017 on Wednesday, to 1.8% from 2.5%, citing weak real personal consumption expenditures, or PCE, after the U.S. Bureau of Economic Analysis said the core PCE index rose by 1.74% year-over-year, below expectations of 1.8%. The currency and bond markets seem to be ignoring the fact that the core PCE index, the preferred inflation indicator for the Federal Reserve, is still well below the Fed target of 2%. The median and central tendency PCE inflation projections are 1.9% and 1.7 - 2.0%, respectively for 2017, according to the Fed economic projections at the December FOMC meeting.

Late Friday, Fed Chair Janet Yellen told the audience at the Executives’ Club of Chicago that, “We currently judge that it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect.” The Fed may be pinning its hopes on the nonfarm payroll report due on March 10. 

The current probability of a quarter percentage point hike, in the target of the Federal funds rate to 75 and 100 basis points at the March 14-15 FOMC meeting, is 79.7%, based on CME Group 30-Day Fed Fund futures prices. The odds that the Fed rate hike cycles will end up badly are also high. According to David Rosenberg at Gluskin Sheff, the U.S. economy landed in recession 10 out of 13 times the Fed hiked rates since WWII.

The yield of 10-year U.S. Treasury Notes jumped 7.79% this week, to close on Friday at 2.49%, while the yield spread between the 10-year and 2-year U.S. Treasury Notes continued to narrow to 1.17 percentage points, signaling the economy could be heading in the wrong direction. The yield of the 10-year Treasury Note has fallen about 4.23%, from its 52-week high of 2.6%, since the Federal Reserve’s second interest rate hike at its December FOMC meeting, and is now stuck under the trendline resistance. The spot gold price dropped 2.53% for the week, to close at $1,226.50 per ounce on Friday, while the Japanese yen was down 1.66% against the U.S. dollar. 

The WTI crude spot price declined 1.22% for the week, closing at $53.33 per barrel on Friday, while the Brent crude spot price also lost 2.26% for the week to close at $55.06 per barrel, after Reuters reported on Thursday that Russian is in weak compliance with the OPEC/non-OPEC crude oil production cut agreement. According to Reuters, Russia may have cut about 100,000 barrels per day, or bpd, so far, or only about a third of the levels pledged to cut under an agreement with OPEC. Speculative long positions in WTI crude oil futures contracts held by money managers totaled 429,168 contracts as of February 28, 2017, a decline of 19,678 contracts, according to data from the U.S. Commodity Futures Trading Commission, or CFTC.

The EIA weekly U.S. oil inventory report on Wednesday showed that domestic crude supplies increased by another 1.501 million barrels to a record 520.184 million barrels, excluding the Strategic Petroleum Reserve, in the week ending February 24, compared to the S&P Global Platts forecast for a stockpile increase of 2.1 million barrels. The American Petroleum Institute, or API, inventory data on Tuesday showed a U.S. crude inventory increase of 2.5 million barrels. 

Separately, the EIA said the weekly U.S. crude oil production decreased 31,000 bpd, for the week ending February 24, to 9.032 million bpd. U.S. crude oil output increased 56,000 bpd to an average of 8.997 million bpd in February, compared to a January average of 8.942 million bpd. Output has fallen about 6.28% from the peak level of 9.60 million bpd in June 2015. Houston-based oilfield services company Baker Hughes Inc. said on Friday that the U.S. oil rig count rose another 7 to 609, compared to 316, when the rig count hit the low on June 6, 2016. 

S&P 500 Summary: +6.44% YTD as of 03/03/17 
Barclay Hedge Fund Index: +2.72% YTD 

Outperforming Sectors: Information technology +10.49 YTD, Healthcare +9.80% YTD, Financials +6.96% YTD, Consumer discretionary +6.76% YTD, and Consumer staples +6.37% YTD.

Underperforming Sectors: Materials +5.77% YTD, Industrials +5.59% YTD, Utilities +5.35% YTD, Real Estate +3.26% YTD, Telecommunication services –3.36% YTD, and Energy –5.50% YTD.

S&P 500 ANALYSIS

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