The Daily Prophet: Can't Complain About a Lack of Volatility

Connecting the dots in global markets.

Tuesday was a day of wild swings in the markets, with the Dow Jones Industrial Average quickly surging above the 26,000 level for the first time only to give up the gains and finish lower by 10.33 points, or 0.04 percent, to 25,792.86. In all, the benchmark swung about 400 points from its high to its low of the day. Who said volatility is dead?

Although commodities producers and industrial shares were largely to blame for the reversal, and it's too early to say this is the start of a prolonged slump, the action suggests there is a limit to investor exuberance heading into earnings season. Or, maybe all the good news is priced into stock prices. “This is going to be a philosophical question within the market, in terms of how much higher earnings growth from tax cuts is worth in terms of valuation, and how much is it worth just purely on a dollar per share earnings basis,” Jurrien Timmer, director of global macro at Fidelity Investments, told Bloomberg News. Thanks to the U.S. tax cut passed into law in December, analysts have been raising their estimates at a rate not seen in at least six years, according to Bloomberg News' Lu Wang.

Forecasts for 2018 profit from companies in the S&P 500 Index increased 3.5 percent over the past four weeks to $151 a share, the fastest pace over comparable periods in Bloomberg data that go back to 2012. Investors tempted to reduce their exposure to stocks after the S&P 500’s successful start to 2018 might be wise to hang on a bit based on historical trading patterns, Bloomberg News' Sarah Ponczek reports. More than 40 percent of companies in the benchmark index traded at a 65-day high Friday, the most in almost five years, according to Strategas Research Partners. Since 1990, when more than 30 percent of S&P 500 companies hit 65-day highs, returns were positive in the next 3 months almost 85 percent of the time.

The dollar is on an epic slide. The Bloomberg Dollar Spot Index reversed its gains to fall for a fifth straight day. One would have to go back to go back to the very start of 2015 to find the last time the index as was weak as it is now. Given the rally in U.S. equities and the idea that the Federal Reserve will raise interest rates another three times this year, the weakness is a bit of a headscratcher. The strategists note that the latest weakness in the dollar emerged on Dec. 13 and coincided with a sharp rise in bond yields. They conclude that this indicates the key factor driving dollar weakness is likely concern that the U.S. tax reform bill will not pay for itself via faster growth. A report by the Joint Committee on Taxation published at the start of December argued that the bill would create a revenue loss of about $1 trillion over 10 years. And because of the rising government budget deficit and the Fed running down its balance sheet, Deutsche Bank estimates the supply of U.S. Treasuries that investors will need to absorb will almost double to $1 trillion in 2018. That's not good for the dollar given how much the U.S. depends on foreign investors to buy its debt and finance its deficits.

It's been a tough few months for bond bulls, as the yield on the benchmark 10-year Treasury rose from 2.01 percent in early September to 2.60 percent last week. Now comes Bank of America's latest monthly survey of portfolio managers, and embedded in the results is something that on the surface looks extremely bond bearish but could actually lift the spirits of the bulls. The allocation to equities among survey participants is at a two-year high of net 55 percent overweight, while the allocation to bonds is at four-year low of net 67 percent underweight. That makes investors the most overweight equities relative to government bonds since August 2014. But a look back to that time shows that was no reason to sell bonds. In fact, the yield on the benchmark 10-year Treasury went from about 2.40 percent to about 1.64 percent the following January. And while yields did go back up after that, to above 2.40 percent by mid-2015, they then fell anew, all the way down to less than 1.40 percent in mid-2016. Here's something else for the bulls: CFTC data show hedge funds and large speculators are the most bearish on 10-year Treasuries since March, which is when yields topped out before slowly descending through early September.

Emerging-market stocks continue surge, closing in on a record set in 2008, but some pretty influential people and Wall Street firms are expressing caution. The MSCI Emerging Markets Index has been on a tear for two years, rising 77 percent from its cycle lows in January 2016. That beats the 49.5 percent gain in the MSCI All Country World Index and the 49.2 percent jump in the Standard & Poor's 500 Index. Yet, contrarians abound, with Morgan Stanley saying EM equities may see a repeat of 2000, which began well but ended with a 32 percent drop, Bloomberg News' Ben Bartenstein reports. Jeff Gundlach, chief investment officer at DoubleLine Capital, says a near-term rally in the dollar and valuations at near-record levels will probably prove a temporary setback for developing-nation stocks. Goldman Sachs says records for global stocks imply a higher risk for a market retreat. The firm notes that the MSCI Emerging Market Index is on its longest streak without a 10 percent correction.

It was fun while it lasted. After a robust rally, metals prices are starting to pull back, led by copper, which is suffering its biggest loss in six weeks. Aluminum, zinc, lead and nickel also retreated on Tuesday as investors focused on the rebounding dollar and evidence of ample supply in the physical market, according to Bloomberg News' Mark Burton. Palladium and other precious metals also retreated, with spot silver falling as much as 3.2 percent. “We’ve had a significant rally across base metals, and it’s hard to justify a further move higher at these levels,” Warren Patterson, a commodities strategist at ING Groep, told Bloomberg News. Metals have been on a tear since May as enthusiasm over growth in China and demand from electric vehicles lured investors. The rally sent copper above $7,000 a metric ton for the first time in three years and palladium to a record.

The Bank of Canada will be in the spotlight Wednesday as policy makers at the central bank meet. The speculation among traders is that they will raise their benchmark interest rate to 1.25 percent from 1 percent, but temper any expectations of much tighter monetary policy amid the possible breakup of Nafta, a stronger Canadian dollar and growing household debt, according to Bloomberg News' Maciej Onoszko. A survey of 22 economists conducted by Bloomberg News from Jan. 5 to Jan. 10 found that Canada's economy is expected to expand by 2.2 percent in 2018, slower than the 3 percent in 2017. At the same time, they see inflation accelerating to 2 percent this year from 1.6 percent.

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