Closing Market Summary: Stocks Rebound as Rising Oil Boosts Risk AppetiteThe stock market ended the midweek affair on a higher note as a rally in crude oil futures and financials (+1.5%) outweighed some lingering rate jitters. The Dow Jones Industrial Average (+0.6%) finished ahead of the Nasdaq Composite (+0.5%) and the S&P 500 (+0.4%).
Index futures climbed in pre-market action, receiving a boost after the release of a weaker-than-expected reading of the ADP National Employment Report for September. The report indicated the addition of 154,000 (consensus 171k) private sector payrolls in September, but it is worth remembering that the Employment Situation Report, which will be released on Friday, carries a lot more influence. The September Employment Situation Report will be released on Friday at 8:30 ET (consensus 176,000). The hiring landscape remains in focus as participants continue refining their rate hike expectations.
Interest rates edged higher, keeping a lid on the market after the ISM Services Index for September handily beat expectations. The index jumped to 57.1 (consensus 52.8) from 51.4 in August. The Treasury complex sold off in response as yields moved higher across the curve. The increase in interest rates pressured defensively-oriented real estate (-1.9%), telecom services (-1.8%), utilities (-0.3%), and consumer staples (-0.2%) for a second straight session.
A rally in crude oil also contributed to strength in growth-sensitive sectors. The energy component extended an early lead after the Department of Energy confirmed a positive reading from the American Petroleum Institute. The EIA reported that crude oil stockpiles declined by 2.97 million barrels (consensus: +2.56 million) while gasoline inventories rose by 0.22 million barrels (consensus: +0.70 million). WTI crude finished the day higher by 2.2% ($49.76/bbl; +$1.08).
The benchmark index finished off its session high, testing technical resistance near the 2160 price level. Seven sectors settled in the green with financials (+1.5%), energy (+1.4%), and materials (+0.7%) leading the advance.
The heavily-weighted financial (+1.5%) sector topped the leaderboard as steepening in the yield curve improved the earnings potential for the group. The spread between the 2-yr yield and 10-yr yield expanded to 89 basis points. Money center banks and life insurance names outperformed as MetLife (MET 45.99, +1.12) and Wells Fargo (WFC 44.99, +1.24) gained 2.5% and 2.8%, respectively. The broader group has gained 1.4% this week, leading the remaining sectors on the weekly leaderboard.
The high-beta chipmakers outperformed in the technology sector (+0.4%), evidenced by the 0.7% gain in the PHLX Semiconductor Index. Broadcom (AVGO 173.48, +4.43) gained 2.6% after receiving an "Outperform" designation at Bernstein. Micron (MU 17.70 -0.10) settled modestly lower as a disappointing gross interest margin masked a bottom-line beat. Separately, Twitter (TWTR 24.87, +1.35) gained 5.7% after reports indicated that the company could receive takeover bids as early as this week. Recall that Alphabet (GOOG 776.47, +0.04), Microsoft (MSFT 57.64, +0.40), Disney (DIS 92.45, +0.14), and Salesforce.com (CRM 68.42, -4.21) have previously been cited as potential suitors.
Retail names displayed relative strength in the consumer discretionary space (+0.4%) as the SPDR S&P Retail ETF (XRT 43.99, +0.58) gained 1.3%. In the group, apparel retailers led as Nordstrom (JWN 53.00, +1.35) and Gap (GPS 22.53, +0.75) moved higher by 2.6% and 3.4%, respectively. Conversely, discount retailers underperformed for a second session as Dollar Tree (DLTR 75.12, -1.31) weighed on the group.
Treasuries finished near their worst levels as yields rose through the curve. The yield on the 2-yr note increased one basis point (0.83%) while the yield on the benchmark 10-yr note rose two basis points (1.70%).
Today's participation was above the recent average as more than 962 million shares changed hands on the NYSE floor.
Today's economic data included weekly MBA Mortgage Index, ADP Employment Report for September, August Trade Balance, Factory Orders for August, and ISM Services for September:
- The MBA Mortgage Index indicated that mortgage applications rose 2.9% in the week ending October 1. This followed a 0.7% decline in the prior week.
- ADP said an estimated 154,000 positions (consensus 171,000) were added to private sector payrolls in September, almost all of which came from the Service-providing sector (151,000).
- Small businesses added 34,000 jobs, midsized businesses increased their payrolls by 56,000 positions, and large businesses added 64,000 jobs.
- The Trade balance report for August showed a widening in the deficit to $40.7 billion (consensus -$39.1 billion) from $39.5 billion in July.
- Factory orders increased 0.2% in August (consensus +0.1%) following a downwardly revised 1.4% increase (from 1.9%) in July. Total manufacturing shipments were unchanged after declining 0.4% in July.
- The ISM Non-Manufacturing PMI increased to 57.1 in September (consensus 52.8) from 51.4 in August.
- September marked the highest reading for the index since October 2015.
Tomorrow's economic data will be limited to September Challenger Job Cuts and weekly initial claims (consensus 258k), which will be released at 7:30 ET and 8:30 ET, respectively.
- Russell 2000: +9.9% YTD
- Nasdaq: +6.2% YTD
- S&P 500: +5.7% YTD
- Dow Jones: +4.9% YTD
The trend is your friend (until it points to a 2017 recession)
Our economists do not expect a recession in the coming year, forecasting slow and
steady growth in the US. But over seven years and more than 270% into this bull market,
one wonders how much longer this cycle can last. We have not yet found a model that
accurately forecast recessions, and even if we did, not all recessions result in bear
markets. But in examining some of some of our favorite indicators’ recent trends, we did
find evidence for an imminent recession. While the range of signals is wide, in aggregate
they do suggest that, if data were to continue to weaken in line with the recent pace,
history would point to a recession in the second half of 2017. Admittedly, other macro
indicators, such as consumer confidence and initial jobless claims, still point to healthy
growth. But historically, equity returns have been strongest prior to the peak in building
permit issuance growth (2012 in this cycle) and the probability of a bear market has
been high when the yield curve was inverted (not until 2018 based on the trend).
Who needs euphoria when you have complacency?
One ingredient seemingly missing from this bull market has been investor euphoria. Wall
Street sentiment is more bearish on stocks now than it was during the Financial Crisis, and
fund managers continue to sit on high cash levels. However, actual holdings data suggest
that positioning may not be so defensive. Large cap active managers have the highest
cyclical exposure since 2012 and their overall beta exposure is near cycle highs. Meanwhile,
equity funds (mostly passive) have seen over $100bn more inflows over the last five years
than during the same period ahead of the 2007 market peak. We also estimate that US
household equity exposure has risen to levels similar to where markets peaked in 2007. With
the stock market having returned roughly three times as much as bonds this cycle, much of
the increase in households’ equity allocation was likely the result of outperformance rather
than a big shift in preference for stocks. But whether deliberately or unwittingly, investors
have 50% more equity exposure than the 60-year average.
Selling too early at the end of a bull market can be painful
Even if we are in the later stages of this bull market, and despite our concerns regarding a
near-term market correction, we caution long-term oriented investors against reducing their
equity exposure too much. History would suggest that unless you can pinpoint the peaks and
troughs of the market to within 12-month timeframes, you would have been better off
staying invested. Some of the best returns often come at the end of bull markets, and these
gains are usually enough to offset the subsequent losses. So while today’s elevated
valuations suggest that we may have pulled forward part of the market’s future returns, our
3500 S&P 500 target for the year 2025 suggests that investors can still achieve mid-single
digit annual returns from stocks in the coming decade.
Buy Quality for the near term and the long term
But what types of equities you own is important, and we continue to recommend that
investors take advantage of the low quality rally to rotate into higher quality companies
with solid balance sheets. Not only are high quality stocks cheap, underowned and one
of the best hedges against rising volatility, but high quality stocks have never had
negative returns over any 10-year period in our history back to 1986 — even excluding
dividends (which have accounted for over 30% of the S&P 500’s total returns over the
last decade). History suggests that while high quality stocks often lag in late bull market
rallies, they usually make up for it when the cycle rolls over.