Push pause. Equity markets ended last week in the red capping off a difficult week for the bulls. Stocks were still reeling from the rapid decline in Treasuries when Friday’s employment situation number came out and caused further selling. Newly created jobs missed expectations, the unemployment rate was lower than expected, and wage growth came in right on expectations, though the report was viewed as being very positive for the economy, which it absolutely, unequivocally was positive. Hot numbers in a hot economy should give the Federal Reserve a case for raising interest rates faster and it is this projection that usually causes weakness in bonds across the board. What is interesting about that most basic of bond trading theses is that it had largely been ignored until last week as longer maturity bonds traded in a narrow range for much of the year while shorter maturities steadily increased under the control of the Fed causing the yield curve to flatten considerably.
There are many reasons for the longer treasuries to remain strong, namely demand from foreign entities seeking safe haven and better relative risk adjusted yields and many traders were frustrated with the extremely low yields that have persisted. That all changed last week as we entered a phase where rates really do matter again. In Friday’s trade the large cap S&P500 closed off its session lows in the red right above a support line of 2864 and the only support below is the Fibonacci retracement line at 2848 (see chart 4 in my attached daily chartbook). The Dow Jones Industrial average closed in the red as well on Friday. The index was unable to hold the weak support at 26500 but managed to close right around another weak support level. The only strong support for the Dow is at 26000 (see chart 6 in my attached daily chartbook). Tech was hit hard once again on Friday, which caused the tech heavy NASDAQ 100 to trade off. The index bounced off of a key Fibonacci support line at 7334 - a close below that retracement line would put the index in neutral with a risk-off signal right around the corner (see chart 8 in my attached daily chartbook). The small cap Russell 2000 index continued to drop on Friday as it bounced off of its 200 day simple moving average, though it managed to close off of its session low. The index will get support from a 1625 Fibonacci line and its 200 SMA but a close below those levels would cause a risk-off signal as mid term momentum is negative and trending down (see chart 7 in my attached daily chartbook).
As I mentioned in several of my past posts, the index has been suffering from a rotation of funds out of the riskier small caps into the “safer” large caps. Additionally, the effects of fiscal stimulants, which were a big boost to smaller cap companies earlier this year, are beginning to wane causing pressure on the index. The S&P500, Dow, and NASDAQ 100 continue to be constructive and the R2K remains neutral with a negative watch. Something to watch in the upcoming sessions will be the US dollar, which strengthened over the weekend largely in part due to the Chinese PBOC (People’s Bank of China aka the Chinese central bank) lowered reserve requirements for lenders and currency holders causing the Yuan to weaken against the dollar. This can be seen on chart 14 in my attached daily chartbook as the currency shot up overnight and is trading right below the recent high of 6.93. This can be a drag on the equities if the news begins to take center stage. 10 year treasury rates climbed again on Friday bouncing off 3.25% closing at the highest yield in 11 years. The 10 year ended Friday’s session at 3.23% and will get a rest today as treasury trading is closed for Columbus day.
The week ahead will be chock full of releases and events that will surely influence significant activity in both equities and fixed income. In economic releases, we will get the price indices starting with the PPI tomorrow. Traders will watch those numbers closely for hints of inflation and they may be more sensitive than usual in the wake of Friday’s employment number. Later in the week we will get the University of Michigan sentiment indicator. The US Treasury will auction 3 year, 10 year, and 30 year bonds. Auctions when treasuries are trading at range extremes can have interesting results, so these ordinarily obscure events (for equity traders) will most likely get some news coverage. Finally, earnings season unofficially kicks off this week with some of the larger financial stocks reporting. Earnings will take center stage once again as traders look for fuel for a continued bull market. Earnings are largely expected to beat expectations, though expectations have been slowly creeping down, essentially lowering the bar. The lowering of expectations will add to volatility as earnings will be more carefully scrutinized this time around. Refer to the attached economic and earnings release calendar’s for specifics. So it will be another week of volatility as many new drivers converge upon the markets and traders will have to decide which buttons to push next.