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Market Update: Tuesday, November 15, 2016

Market Update

  • Stocks up along with oil as bond market takes a breather. U.S. equities are modestly higher in early trading, boosted by a 4% rise in the price of WTI crude oil ($45.17/barrel) as investors hope for a production cut from OPEC at the end of the month. Government bonds are pausing for the first time since the election; the yield on the 10-year Treasury is down to 2.21%, after trading as high as 2.25% yesterday. The Dowinched to a new high yesterday as the broader market searched for direction; the S&P 500 closed flat as financials surged another 2.3%, offset by a 1.7% loss in technology. Overnight in Asia, markets were little changed, though the Chinese yuan/dollar ratio reached its lowest level since 2009. European markets are similarly mixed following a barrage of economic data. Finally, COMEX gold ($1225/oz.) is up modestly while the dollar is trading near flat.

Macro View

  • Treasury yields saw a sharp move higher last week, following Donald Trump’s surprise win in the presidential election. The jump of 0.34% to end the week at 2.15%, was the largest percentage move in Treasuries (just over 21%) since records started in 1962. The 30-year Treasury also saw weakness, with yields moving 0.36% higher to 2.96%. Moves of this magnitude are very rare, bringing up the possibility of a reversion to the mean once markets are able to get more details on President-elect Trump’s policy plans. We discuss the drivers behind this move in more detail in this week’s Bond Market Perspectives, due out later today.
  • Trump’s fiscal plans weigh on bond market.President-elect Trump’s fiscal stimulus plan sent rates soaring last week, leading to the worst one-week return (-1.5%) for the broad bond market (represented by theBarclays Aggregate) since the Taper Tantrum of 2013. Treasuries fared worse, returning -1.9% (according to the Barclays US Aggregate Government Treasury Index). TIPS (-0.9%, as measured by the Bloomberg Barclays U.S. Treasury Inflation Notes Index) were able to outperform Treasuries due to the sharp rise in inflation expectations. Bank loans (+0.1%, as measured by theS&P/LSTA Leveraged Loan Total Return Index) were the only sector with a positive return for the week. High yield showed resilience, and spreads over comparable Treasuries declined, but the Barclays High Yield Bond Index still posted a negative return of -0.1%. Investment-grade corporate bonds were hurt by their longer duration, but spreads over comparable Treasuries declined there as well.
  • Inflation expectations rise amid expectations for fiscal spending. Inflation expectations also moved higher last week, with 10-year breakeven inflation (as calculated by the difference between the 10-year Treasury yield and 10-year TIPS yield), moved 0.21% higher to 1.88%, and 30-year breakeven moved 0.24% higher to 2.09%. This news is a positive for the Fed, and likely moves them even closer to a rate hike at their upcoming December meeting.
  • Rate hike expectations notch up. Moves in the Treasury market showing initial conviction in President-elect Trump’s plan to boost economic growth with fiscal stimulus are being confirmed in fed fund futures markets. Assuming higher growth and inflation, the fed would likely pursue a more aggressive normalization trajectory than it would have otherwise. The fed funds futures market is currently pricing in a 92% chance of a rate hike in December, the highest level we have seen. Additionally, the futures market estimate of the long-term fed funds rate has moved up significantly as well, from 1.7% as of November 4, 2016 to 2.2% as of November 11, 2016. This is closer to, but still below, the fed’s projection of the long-run rate of 2.9%.
  • Municipal bond valuations richen relative to Treasuries. Municipal bonds saw losses as well (-0.98%, Barclays Municipal Bond Index), though they outperformed Treasuries, leading 10- and 30-year AAAmunicipal-to-Treasury ratios toward the more expensive end of their recent range, ending the week at 90% and 95% respectively. Municipals normally outperform Treasuries during periods of rising rates like we saw last week, and the fact that municipals had been seeing weakness versus Treasuries in recent weeks was likely a tailwind for the sector
  • Dow higher again. The Dow Jones Industrial Average gained for the sixth consecutive day and closed at a new all-time high for the third straight day. It had a streak of seven consecutive new highs in July 2016. The record is 12 from January 1987. Dow transports had another big day yesterday and have been one of the top performers since the election. When both Dow Industrials and Transports make a new high that is called a Dow Theory buy signal. Charles Dow created the Dow Theory in the late 1800s and it revolves around simultaneous advances in industrials and transports to confirm market strength. We will take a closer look at this technical development today on the LPL Research blog.
  • Continued strength under the surface. The broad-based strength of the rally the past few days has been impressive, as many of the smaller names have been leading. Remember, there are many more small caps than large caps – so this helps overall market breadth. We’ve mentioned advance/decline lines before as one of our favorite ways to measure market breadth. An advance/decline line is simply a cumulative tally of how many stocks are up or down on various exchanges each day. Yesterday, we saw new highs on both the S&P Mid Cap and S&P Small Cap indexes, confirming the strength from these groups. The larger indexes are close, but haven’t made new highs yet.
  • Strong October retail sales keep Fed on track to raise rates in December. Core retail sales-which feed directly into gross domestic product (GDP) as consumer spending-posted a 0.8% month-over-month gain in October, exceeding consensus expectations (+0.4%) and accelerating from September’s 0.3% reading. Adding to the positive tone, the September reading was revised higher from 0.1% to 0.3%.  Retail sales in October (the first month of Q4 2016)  were running 3% ahead of their Q3 average, putting a solid floor under GDP in Q4. In addition, the upward revision to September retail sales is likely to boost the Q3 GDP reading (initially reported as +2.9%) to over 3.0%. The one caveat to the report is that the data were collected before the surprise election result in the U.S. Still, the October retail sales report suggests that the economy was growing well above potential in Q4 2016, putting upward pressure on resources and the labor market, keeping the Fed on track to raise rates in December.
  • November Empire State Manufacturing report suggests manufacturing sector stabilizing in Q4. At +2, the November reading on the Empire State manufacturing index was above expectations (-3) and a big improvement from the -7 reading in October. A reading above zero on this index points to an expanding manufacturing sector in the New York region. The details of the report were in line with the headline-which is not always the case with this report-as new orders turned positive, shipments increased and delivery times lengthened. The employment readings in the report remained soft.

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