Stocks Continue Rebound as the VIX Retreats

HI_Market Notes header_2182019

Retail sales looked to be the “big number” for the week, and they disappointed when released on Thursday, showing a much worse than expected decline of -1.2%.  However, largely overlooked in the headline number was the fact that this represented a year-over-year increase of 2.3%.  Regardless, stocks rallied anyway, up 2.5% (S&P 500) on the week as measured by the S&P 500.

There’s been a certain repetitiveness to the economic story of late, dominated by trade discussions with China, mixed messages from U.S. and European data, and Brexit.  In the U.S. initial jobs claims continued to creep up even as the JOLTs Job Openings were meaningful higher, with 7.3 million job openings reported at year-end 2018. U.S. Industrial production was down, contracting the most since last May but the New York Empire State Manufacturing Index was up, suggesting expansion.

In Europe, the economic data was less than stellar, though U.K. retail sales were better than expected, and the French unemployment rate surprised by falling.  Balanced against this was a lower than expected number for U.K. GDP and a more than forecast decline in that country’s Manufacturing Production.  For its part, Chinese Import & Export data was much better than anticipated, suggesting that stimulus efforts were starting to have an impact.  In Japan, the colorfully-named Tertiary Industry Activity Index missed estimates.

Back in the U.S., a reset of earnings expectations coming out of 4Q 2018 may be helping equity performance. With earnings season more than three-quarters of the way complete, S&P 500 companies have seen the best reaction to negative EPS surprises in nine years.

Last week’s rally was led by energy shares following a rise in crude prices. Industrial stocks were also up, with more positive trade news than negative over the week.  For the year, the S&P 500 Industrials is up 16%, a top performing sector.  The Nasdaq, for its part, continued to climb, up more than 20% from the December low. Defensives lagged as investors took a more “risk-on” stance.  Utilities were the worst performers on the week (slightly higher interest rates probably played a part in their weakness) and communication services equities also underperformed.

In foreign markets, European stocks rallied, led by the cyclical sectors.  Here, too, trade talk progress, dovish rhetoric out of the ECB and BoE and the potential that the ECB injects banks with fresh cheap capital/loans, were catalysts. As in the US, European defensives lagged. In Asia, Japanese shares appreciated due to mostly positive global macro headlines; earnings growth momentum seemed to subside, however, likely limiting upside.

Emerging markets also seemed to have lost some momentum from earlier in the year, falling slightly and down for the second week in a row.  Brazilian shares were a bright spot, rallying after confirmation that a formal Pension Fund proposal would be presented to Congress next Wednesday with a minimum retirement age of 65 for men and 62 for women, exceeding expectations.

In the fixed income market, high yield bonds outperformed, benefiting from risk-seeking behavior while longer-duration bonds underperformed shorter-duration bonds. Emerging market currencies continued to lose ground to the dollar, with negative consequences for both sovereign and corporate debt.

GAIN: Active Asset Allocation
Global stocks posted another solid week, continuing to recover from the December sell-off.  U.S. small cap was up a little over 17% on the year, and 4% in the past week, based on Morningstar indexes. The Nasdaq saw its eighth consecutive weekly rise, closing more than 20% above its December low and moving out of bear market territory.

Several major indices are now above key technical levels, including the S&P 500, which closed above its 200-day moving average on Tuesday and pushed higher from there. High yield bonds rallied, too, as fixed income broadly saw a return to normal levels of liquidity.

Sentiment has been improving as well, e.g., the CNNMoney “Fear & Greed” indicator, which looks at stock price momentum and market breadth among other factors, was solidly green — though many investors remain on the sidelines.

PROTECT: Risk Assist
The CBOE Volatility Index (VIX) ended the week at its lowest level since last October, consistent with a move towards risk-off.  From a 12-month high of 36 on Christmas Eve, it has been in steady retreat and now stands just below 15.  Meanwhile, U.S. equities are up more than 18% off their December lows, while global stocks are up more than 15% and small caps have risen over 24%.

SPEND: Real Spend
Inflation continues to be the dog that doesn’t bark, with both the CPI and the PPI coming in a little softer than expected.  Headline CPI was 1.6% year over year; PPI was 2.2%.  These numbers are likely to reinforce the Fed’s current stance that additional rate hikes are not needed.

Treasury yields bounced around, falling sharply on weak retail sales then springing back, with the 10-year ending the week yielding 2.66%.  High yield bonds outperformed, while utilities were off.  Both domestic and foreign dividend indexes declined modestly as investors moved away from their defensive tilt. Mortgage bonds fell slightly.  The Morningstar MLP Composite Index was up.  The 1-year spread between stocks and bonds continued to shrink with global stocks down -2.5% and investment grade bonds up +3.5%.

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Stocks Continue Rebound as the VIX Retreats

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