The Daily Prophet: Equities Are Quickly Running Out of Momentum

Connecting the dots in global markets.

On the surface, it all looks pretty good for equities. The Dow Jones Industrial Average, S&P 500 Index and Nasdaq Composite Index continue to creep higher to new records. It's some of the more specialized indexes that are starting to send some worrisome signals.

Take the Dow Jones Transportation Average, which is loaded with railroads and airlines, and is sometimes called the market's early warning system. The gauge has broken with the more widely followed Dow Jones Industrial Average, falling 4.06 percent from its high this year on Oct. 12. Then there's the S&P 500 High Beta Index, which tends to lose momentum faster than the broader market at the tail end of an uptrend. That gauge is essentially flat since mid-October. Finally, the S&P 500 Momentum U.S. Dollar Index had its biggest drop in three weeks on Wednesday. Some strategists say that for equities to continue their rally, there would need to be substantial progress in Washington on tax cuts to justify their lofty valuations. The news, though, seems to be going against the stock bulls. 

The Washington Post reported late Tuesday that Senate tax writers were considering a one-year delay in implementing a 20 percent corporate rate, down from the current 35 percent. In an interview with Bloomberg TV on Wednesday, Treasury Secretary Steven Mnuchin said he isn’t ruling out delaying the start of the corporate tax rate cut, but emphasized the administration’s “strong preference” is for it to take effect in 2018.

There's another market that's also considered an early-warning system, and it's sending the same signals as the transports.  By one measure,  corporate junk bonds had their worst day in two months as yield spreads blew out by 5.5 basis points, according to Bloomberg News' Sebastian Boyd. What started as weakness in sectors such as communications and consumer non-cyclicals quickly turned into a market-wide selloff. The bonds of energy companies were some of the other big losers. Boyd reports that there is an accumulation of bad news around some of the biggest names in the market, and investors seem to be selling first and asking questions later. It probably wouldn't take much for the junk bond market to suffer sustained losses. Concerns have been rising for some time about higher leverage ratios, especially with the Federal Reserve not backing down from its plan to keep boosting interest rates. The market for junk-related debt has long since ceased to be a niche, and few could even argue that it's now a threat to the financial system. S&P Global Ratings estimates there was almost $2.47 trillion of U.S. corporate debt rated below investment as of June 30. Of that amount, about $1.5 trillion is scheduled to mature through 2022, creating rollover risk.

Copper is up 23 percent this year at $6,820 a ton on the London Metal Exchange. The frenzy in the market is luring traders to take high-flying bets that prices are headed much higher. Bloomberg News' Mark Burton reports that call options wagering on copper climbing above $10,000 a metric ton by December 2018 have started trading during the past two weeks, LME data show. In total, traders have spent about $4.5 million on the contracts. Copper hasn’t traded at those levels since 2011, the peak of a commodities boom mainly fueled by a roaring economy in China, the biggest user. The bulk of the wagers came last week during the mining industry’s annual gathering in London and suggests traders are becoming increasingly bullish on demand driven by electric cars. “It’s like a lottery ticket,” Leon Westgate, a senior analyst for base metals and bulks at Levmet U.K. Ltd., told Bloomberg News. The bets will pay off handsomely if the options expire in the money. Traders bought $2.5 million of options on Nov. 2 that would pay out about $10 million if copper reaches $10,200 by December next year, data compiled by Bloomberg show. The options would be worth $28.8 million if copper hits $10,500.

Most of the island's electricity system may still be down since Hurricane Maria hit, but that's not stopping trading in Puerto Rico's bonds. In fact, it's starting to get much more active. The volume of trading in Puerto Rico debt is at the highest in at least three years as the island seeks as much as $21 billion in aid to help keep the government operating and paying public employees, according to Bloomberg News' Michelle Kaske. The trailing 30-day daily average of commonwealth securities traded reached $423.3 million on Monday and $422.7 million on Tuesday. The rising volume may not represent a one-way trade of bondholders seeking to get out of the debt amid a 16.8 percent collapse this year in an index of the island's securities. In fact, some prominent investors say it might be time to load up on Puerto Rico bonds, Kaske reports. “With Puerto Rico general obligation bond prices down more than 40 points since March, trading for roughly 30 cents on the dollar, we think valuations are looking more favorable than in the past,” David Hammer, Pacific Investment Management Co.'s head of municipal bond portfolio management, just wrote in a quarterly report posted on the firm’s website. Investors need to consider the risks posed by Puerto Rico’s record-setting bankruptcy and the potential impact of the storm -- and the federal government’s response -- on the island’s economy, Hammer wrote.

It's almost surely a mistake to give all the credit to Donald Trump, but since he was elected president one year ago, the value of the global stock market has increased by $26 billion and the bond markets have added an additional $2 trillion, according to Deutsche Bank economist Torsten Slok. That works out to about $3,684 for every man, woman and child on Earth, based on an estimated worldwide population of 7.6 billion. It's no wonder that the strategists at Societe Generale say that a sentiment indicator the firm created based on credit markets, equities, currency volume, swap spreads and the ratio between gold and equities just this week reached its highest level ever in data going back to 2000. The so-called wealth effect from these gains goes a long way toward explaining the recent rise in consumer and business spending decisions not only in the U.S., but in Europe and emerging markets as well, according to Slok. But there is reason for caution. "Global growth is accelerating, and the chances of overheating and an associated pick-up in inflation are significantly higher than the chances of a recession," Slok wrote in a research note.

The European Commission is due to update its economic projections for the euro area on Friday in Brussels. Judging by the recent performance of the euro zone economy, it's safe to expect another upgrade in the outlook. The Citi Economic Surprise Index for the euro zone -- which measures data that exceed forecasts relative to those that miss -- has risen from less than 10 in August to about 60 currently. A month ago, the International Monetary Fund boosted its assessment of the region's economy, forecasting growth this year of 2.1 percent, compared with 1.8 percent in 2016. The IMF, whose estimate was 0.2 percentage point higher than its forecast in April, cited a pickup in global trade, ongoing strength in domestic demand and diminished political risk for the brighter outlook.


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