What can investors expect after a rollercoaster week? 

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — Oct. 15, 2018

 

The selloff in equities accelerated last week, taking stocks to their third straight weekly decline for the first time since June 2016. The S&P 500 index shed 4.1 percent, but it could have been worse, if not for a 1.4 percent rebound on Friday that allowed the index to close above its 200-day moving average, although just barely. As it is, the index has fallen 5.4 percent in the past three weeks. 

Friday’s rebound was welcome, indeed, as it broke a string of six straight down days, and was led by the very stocks that had fallen the most in the selloff, including technology, consumer discretionary and communication services. Contributing to relative late week stability was a decline in bond yields, whose surge higher two weeks ago was perhaps the primary catalyst for the weakness in equities. The yield on the ten-year U.S. Treasury note ended the week at 3.16 percent, seven basis points lower than the previous Friday. And contributing to that decline was a benign reading of consumer prices for September. 

The market spasm of the past three weeks appears to have been mostly a sudden adjustment to the realization that the Federal Reserve has every intention of continuing to raise rates. If so, we are now back to where we were before the selloff, with the same fundamental concerns, albeit at lower price levels. The ability of stocks to push higher in the near term will depend heavily on the tenor of third quarter earnings. Earnings themselves will, of course, be important. But, perhaps just as important will be what management teams say about the operating environment, and trade in particular. If it becomes apparent that trade is starting to become a meaningful headwind to earnings, planning and confidence, stocks may struggle. With a few exceptions, earnings reports this week are dominated by the financial sector, and to the extent that financial stocks have a more domestic focus and are relatively, although not completely, insulated from trade tensions, we will likely need to wait until the following week and beyond to get a better reading from industrial and technology companies, and others on the front lines. 

Stocks worldwide experience declines; Volatility rises

Eurozone equities traced a path similar to the U.S., as the EuroStoxx 50 index fell 4.5 percent for its third straight week of losses. The Nikkei fell by a similar amount for its second weekly decline in a row. The MSCI Emerging Market index fell for the third straight week. But the comparatively better -2.1 percent return was buoyed by strength in Latin America, notably in Brazil, which is in the preliminary stage of electing a president. In China the Shanghai Composite plunged 7.6 percent, as domestic shares caught up with weakness elsewhere after markets were closed the previous week, leaving that index down 21 percent year-to-date.

Beyond equities, there was some evidence of rising risk aversion in other asset categories as well. High yield credit spreads widened for the second straight week, and the move this time was more pronounced, although hardly evidence of panic selling. The spread between the Bank of America Merrill Lynch High Yield index and the ten-year Treasury note widened 22 basis points, on top of an eight basis point week move in the prior week. However, at 352 basis points, the current spread remains tight and is right at its average of the past twelve months. The VIX index of volatility lurched to its highest weekly close since April, ending the week at 21, compared to 15 the prior week. And gold closed higher by $26 to $1,217 an ounce. 

Investors watching the dollar, oil prices, Italy’s financial status and China’s GDP report 

Conversely, the dollar eased slightly in concert with bond yields, while emerging market currencies rose modestly. And oil fell $3 a barrel on worries over rising U.S. inventories and increased output by OPEC (Organization of Petroleum Exporting Countries). Oil prices bear watching in light of rising tensions between Saudi Arabia and the U.S. in connection with the disappearance of journalist Jamal Khashoggi. 

This week Italy prepares to deliver its fiscal budget to the European Commission. The budget is expected to exceed the spending limits prescribed by European authorities, setting up a confrontation that already has markets on edge. The yield on the ten-year Italian government bond climbed 15 basis points last week to 3.57 percent. Three weeks ago, that yield was 2.82 percent. During those three weeks, the yield spread over the German 10 year has widened by 70 basis points. 

This is an important week for economic data from China. Third quarter GDP is forecast to grow at year-over-year pace of 6.6 percent, down a tenth from the second quarter, according to Bloomberg. China also releases reports on consumer inflation, foreign direct investment, retail sales and industrial production. 

The U.S. economic calendar is full, with reports on retail sales, industrial production, housing starts and existing home sales, and the minutes from the September Fed meeting.