Mixed signals. That's what you and I have seen across the financial landscape of late. Key to equity market volatility has been Treasury market, currency market, and commodity market volatility. The US Dollar surged on Tuesday against the Euro, the British Pound, the Japanese Yen, and the Canadian Dollar.
This strength was driven by the idea that the Federal Reserve appears to be intent on focusing on implementing policy with the intent to slow inflation... at the expense of economic activity. This has put the "whammy" on commodities in general as recession fears rise, and on energy commodities specifically.
Ebbing demand, and dollar strength have impacted not just crude, natural gas, and gasoline futures pricing, but precious metals, industrial metals, and agricultural commodities as well.
Then, we come to US Treasuries. Yields dropped precipitously up and down the entire curve on Tuesday with the spread between the US Ten Year Note and the US Two Year Note inverting on and off throughout the session. Very early this morning, I see US Ten Year paper paying a rough 2.81%, which is what Two Year paper currently gives up. At this moment (and this is changing by the minute), the Two Year is inverted against the Three Year and Five Year, the Seven Year is inverted against the Ten Year, and the Two/Ten is a coin toss at any moment.
The Seven Year/Thirty year spread stands at just +16 basis points, which is awful, as the Three Month/Ten Year yield spread (the most important spread of them all) has contracted significantly since mid-June to stand this morning at just 95 basis points. Take a look at that spread in action over the past two weeks or so...
Chutes and Ladders, oh boy. Remember that the San Francisco Fed has cited the Three month/Ten year spread as the most accurate predictor of economic contraction at its disposal. On that note, recession fears pushed a lot of strange activity across equity markets as well. May Factory Orders surprised to the upside on Tuesday. That did nothing to allay these jitters. The Atlanta Fed does not revise its GDPNow model (currently at -2.1% q/q SAAR) until this Thursday when the BEA puts the June Trade Balance to the tape, and then again on Friday for the BLS "Jobs Day" data.
Equities
Stocks opened deep in the hole on Tuesday morning, with both the S&P 500 and Nasdaq Composite down an early 2% or so. All 11 S&P sector-select SPDR ETFs were shaded deeply in the red early on. Then, the flow of capital shifted. The S&P 500 would rally throughout the day, closing (+0.16%) at the top of its daily range for a second consecutive session after three successive red candles...
As for the Nasdaq Composite, the run for the roses was a bit more aggressive as was investor demand for technology stocks. The Composite closed up 1.75% for the session, recapturing the 11,000 level and pressing up against resistance at its 21 day EMA...
Cause for optimism? Hard to say. While green (or in this case, white) candles are always better than a sharp stick in the eye, we have seen too many bear market rallies throughout this (and past) downturn(s) to really count on much until after the fact. It is clear that as hopes for the US and global economies to potentially skirt recession have faded, that the Energy (XLE) and Materials (XLB) sectors have fallen out of favor. Over the past 30 days, the (XLE) ETF has surrendered 21.26%, while the (XLB) has given up 15.62%.
It has become just as clear that tech stock investors really, really prefer (we already knew this) lower interest rate environments. On Tuesday, the Communications Services (XLC) sector ran 2.32%, while the Technology SPDR ETF (XLK) popped 1.26%. Key industry indices within those sectors were indeed quite hot. The Dow Jones US Internet Index screamed 4.57% higher led by DoorDash (DASH) , Snap (SNAP) , and Pinterest (PINS) . Those three were up 10.23%, 9.19%, and 8.12%, respectively.
There was enough love to spread around. The Dow Jones US Software Index gained 2%. The leaders there were MongoDB (MDB) , up 13.17%, Coinbase Global (COIN) , up 12.99%, and Unity Software (U) , up 12.76%. Even the semiconductors which have come under increased pressure of late, managed to rally. The Philadelphia Semiconductor Index gained 0.78% for the session. Large cap leaders were Wolfspeed (WOLF) , Micron (MU) and Nvidia (NVDA) . These stocks were up a modest (relative to the rest of tech) 7.2%, 5.7% and 3%, respectively. Yes, I see Qorvo (QRVO) up 4.1% on Tuesday, and I do believe at that price QRVO is indeed a large cap, but as you know QRVO fluctuates at a market cap of approximately $10B. Hard to call it a large cap or a mid-cap and be correct a few hours later.
Trader Heads Up, Part One
Chevron (CVX) has found support in the $139/$140 area for the second time in less than two weeks on Tuesday...
The 200 day SMA looms large for CVX as that spot is not only where failure would lead to a reduction in institutional exposure as risk managers tap portfolio managers on the shoulder, but also stands very close to a 50% retracement of the stock's September through early June run. That spot is a big deal for CVX, and for the XLE ETF itself...
Trader Heads Up, Part Two
I am sure that readers noticed the horrific beatdown taken by the large defense contractors on Tuesday. For the day, L3Harris (LHX) gave up 5.05%, Northrop Grumman (NOC) gave up 4.53%, Raytheon Technologies (RTX) lost 4.23%, Lockheed Martin (LMT) surrendered 4.21%, and General Dynamics (GD) spit up 4.17%.
What gives here? First off, Industrials tend to do poorly in recessionary environments, and defense contractors are indeed industrials. Second, these names are indeed industrials heavily reliant upon government spending, and there is speculation that fiscal budgets could be refocused elsewhere despite how dangerous that is at a time like this. Thirdly, as we know, there are a number of foreign governments, mostly US allies, turning to these firms to help them beef up their defense capabilities in the face of Russian aggression.
The problem there, other than the fact that the recession outside of the US is expected to be far more severe than the one inside, is the fact that many NATO allies use the Euro and Euros are weakening versus the US dollar quite rapidly to the point of approaching parity. This ultimately renders potential purchases made in Euros by foreign governments less valuable to these businesses, or if said deals are made in US dollars, unit sales will likely have to be downsized.
What now? If one is heavily exposed to these names, like I have been, like I am still to a slightly lesser degree, one has to think about right-sizing this exposure until there is more certainty. These names have protected us from the market's broader selloff this year. I am not sure that Aerospace and Defense can carry that load on their back much further unless there is a reversal in currency valuations, and unless defense is prioritized in the way that I think it should be. Stay tuned.
Paradox
Point... Falling commodity prices increase hopes that inflation has apexed.
Counter... Falling commodity prices are a harbinger of recession.
Point... Economists currently see labor market strength as key support that will keep the US economy out of recession.
Counter... Economists also see recession as the catalyst that will pop the labor market bubble.
Point... Federal Reserve officials have signaled that the risk of not addressing inflation is greater than the risk slowing the economy due to having to address inflation.
Counter... Traders are now pricing in a dovish turn made by the Fed in response to collapsing economic growth.
Just an FYI...
Futures markets trading in Chicago are currently pricing in a 75 basis point rate hike on July 27th, and a 50 basis point increase on September 21st. (The annual Jackson Hole clambake is held in August.) Then these futures markets see 25 basis point increases made in both November and December, taking the Fed Funds Rate up to 3.25% to 3.5%.
That's it. There are no rate hikes priced in for 2023, but a rate cut is now a majority probability for June 2023.
The Charge of the Light Brigade
(Stanza III)- Alfred, Lord Tennyson
Cannon to right of them,
Cannon to left of them,
Cannon in front of them
Volleyed and thundered;
Stormed at with shot and shell,
Boldly they rode and well,
Into the jaws of Death,
Into the mouth of hell
Rode the six hundred.
Economics (All Times Eastern)
08:55 - Redbook (Weekly): Last 11.7% y/y.
09:45 - S&P Global Services PMI (June-rev): Flashed 51.6.
10:00 - ISM Non-Manufacturing Index (June): Expecting 54.6, Last 55.9.
10:00 - JOLTs Job Openings (May): Last 11.4M.
10:00 - JOLTs Job Quits (May): Last 4.424M.
16:30 - API Oil Inventories (Weekly): Last -3.799M.
The Fed (All Times Eastern)
09:00 - Speaker: New York Fed Pres. John Williams.
14:00 - FOMC Minutes.
Today's Earnings Highlights
(Consensus EPS Expectations)No significant quarterly results scheduled.
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