Year: 2017

Tax reform sparked a rotation into financials, transportation and retail over the past week. A sell-off in Asian shares added to a rotation out of the technology sector.

Diverging sector performance led to a wide index return variance. The Dow Transports and Dow Industrials saw substantial gains, while technology shares pulled the Nasdaq to a loss.

The tight correlation between sectors links the rise in stocks to proposed tax reform. SPDR S&P Retail (XRT) and U.S. Global Jets (JETS) represent industries that pay corporate tax rates approaching the U.S. maximum of 35 percent and have traded in lockstep over the past month. Banks, industrial and consumer stocks also tend to pay higher tax rates. They all outperformed the market over the past week.

Biotechnology, pharma and energy have underperformed over the past week. Guggenheim China Technology (CQQQ) shares tumbled more than 10 percent over the past week as the sell-off in Asian tech shares intensified.

The chart below shows the relative price of Guggenheim S&P 500 Pure Value (RPV) to Growth (RPG). Value shares have outperformed by more than 4 percent over the past week.

iShares S&P 500 Value (IVE) and Growth (IVW) should join RPV/RPG at a new short-term high if a major rotation is underway.

Given market history, a pullback is likely before an extended move.

Chinese stocks have taken a blow over the past week after approaching long-term resistance. We have warned about the risk in recent weeks as China restricts credit growth. Some important monthly figures from October showed a slowdown in the real economy and this finally hit financial markets. Copper prices also declined sharply.

Rate-sensitive sectors, such as utilities and real estate have been moving lower in response to December’s anticipated rate hike. SPDR Real Estate (XLRE) is at a 3-month low and SPDR Utilities (XLU) isn’t far from joining it.

One- and three-month LIBOR have almost fully priced in a December rate hike over the past month.

While short-term rates are rising, long-term rates are holding steady. The 10-year Treasury is in a very mild uptrend, but has remained effectively unchanged since October and trading at the low end of its range. As a result, intermediate- and long-term bond funds have performed well.  Low-duration bond funds such as Thompson Bond (THOPX) and floating rate funds are also doing well.

iShares 20+ Year Treasury (TLT) is approaching its high for 2017 as corporations accelerate pension investments.

The rotation to finance continued Monday. SPDR Financials (XLF) climbed more than 2 percent at the open and closed with a 1.52 percent gain. while SPDR Technology (XLK) slid more than 1.6 percent. Materials, industrials, consumer staples and consumer discretionary also rallied. The Dow Jones Industrials led major indexes. The Dow Jones Transportation Index jumped nearly 2 percent.

The House and Senate versions of tax reform bills will be merged into a final bill that could be on the President’s desk before Christmas. The final corporate tax rate could be as high as 22 percent, but it will represent a significant cut from the current top rate of 35 percent.

Companies that do most of their business in the United States derive the greatest benefit from these cuts, as will banks, homebuilders, truckers, utilities, retail, materials, air transportation and insurance. Over the past six trading days, the S&P 500 has gained about 2 percent.

Factory orders in October slipped 0.1 percent, but beat expectations of a larger decline. Tomorrow the service PMIs will be out. Wednesday will bring revised third-quarter productivity numbers and the ADP employment report for November. The Bureau of Labor Statistic’s employment report will be out on Friday. Economists forecast 204,000 new jobs and a 4.1 percent unemployment rate.

Overseas data will include Chinese trade and inflation figures for November, Canadian housing starts, plus Australian and Japanese third-quarter GDP growth. The Bank of Canada will meet on Wednesday. No interest policy change is expected. Britain reached a border deal with Ireland on Monday. It was a potential sticking point for Brexit.

CVS Health (CVS) will buy health insurer Aetna (AET) for $68 billion to stave off the competitive threat from Amazon (AMZN). In October, Amazon acquired a pharmacy license.

Crude oil opened the week at $58 a barrel and slipped to $57 on Monday. Crude has spent the past month bouncing between $55 and $59 a barrel.

The U.S. Dollar Index rose on Monday as currency markets also priced in the likely passage of tax reform. Odds of a Federal Reserve rate hike in March rose from near 50 percent on Friday to more than 60 percent on Monday.

Autozone (AZO), Toll Brothers (TOL), Broadcom (AVGO), American Eagle Outfitters (AEO), lululemon (LULU), H&R Block (HRB) and Dollar General (DG) will report earnings this week.

Tax reform fueled major indexes to new highs. SPDR Industrials (XLI) and Financials (XLF) rose 3.19 and 5.26 percent.  The Dow Jones Industrial Average gained 2.86 percent. The Nasdaq lost 0.60 percent on the week after making a new high on Tuesday. The Dow Jones Transportation Index climbed 5.89 percent as investors priced in the prospect of faster GDP growth.

October new homes sales hit an annualized pace of 685,000, on par with the robust economic expansions of the 1960s and 1980s. iShares U.S. Home Construction (ITB) rose for the 13^th time in 14 weeks.

The Bureau of Economic Analysis revised its third-quarter GDP growth estimate to 3.3 percent. A third and final estimate is due in December. The Federal Reserve Bank of Atlanta adjusted its fourth-quarter forecast to 2.7 percent growth, in line with the economist consensus.

October personal income, pending home sales, construction and consumer spending all beat expectations. Manufacturing PMIs eased from October highs, but came in stronger than the flash numbers released a week ago. The production subcategory hit its highest level since 2011.

The United Kingdom’s manufacturing PMI hit a 4-year high, while the Eurozone PMI hit a 17-year high. Canada reported job growth of 79,500 in November, more than double the October figure. Adjusted for population, this is more than triple the pace of job growth in the United States. The Canadian dollar erased all of its losses for the week with a big gain of 1.6 percent on Friday, the largest one-day move since early September.

OPEC extended production cuts through the end of 2018 this week. The market anticipated the move and the effect on oil prices was muted. West Texas Intermediate crude oil peaked at $59 last Friday and fell as low as $56 before bouncing. Oil-related equities rallied on the news.

Technology stocks sold off this week as investors rotated into value. SPDR Technology (XLK) fell 1.40 percent. Relative to the rally in financials, it was the single worst week for technology since the brief sell-off in June. Financials, industrials and transportation all saw the best weekly performance in over a year. Utilities (XLU) saw its ninth consecutive weekly gain. Vanguard Value (VTV) increased 2.99 percent this week. Vanguard Growth (VUG) was unchanged.

iShares MSCI EAFE (EFA) fell 0.67 percent this week, behind the S&P 500 Index (SPY) gain of 1.67 percent. iShares MSCI Emerging Markets (EEM) slid 3.90 percent as Chinese shares declined.

News of a coalition government in Germany between Chancellor Angela Merkel’s CDU and the SPD boosted the euro this week. However, late on Friday, the SPD denied there was any talk of a deal. Without the SPD, Merkel can either form a minority government or hold new elections in February. iShares MSCI Germany (EWG) fell 1.02 percent on the week.

Earnings news was light this week. Kroger (KR), the largest independent supermarket chain, reported surprisingly strong earnings despite competition from Amazon (AMZN) and Wal-Mart (WMT). Shares rose 11.7 percent and lifted SPDR Consumer Staples (XLP) 2.7 percent for the week.

Equities rallied to new all-time highs after Senate Republicans on the Budget Committee voted unanimously in favor of the tax bill ahead of Thursday’s anticipated final vote.

Positive news around tax reform jolted financial sector activity, with big gains in banking and brokerage sectors.

SPDR S&P Regional Banking (KRE) and Bank (KBE) made major bullish breakouts from their 2017 trading ranges. Insurance and brokerage stocks were trading at new highs prior to this latest rally.

Major sector rotation is also underway. Technology stocks, such as PowerShares QQQ (QQQ) and iShares Semiconductors (SOXX) tumbled. The one-day loss in SOXX reversed all the gains in November.

Today’s shift, however, it may not last. The current spike in value and drop in growth happened in June, followed by a smaller and shorter spike in September. The Pure Growth (RPG) and Value (RPV) ETFs from Guggenheim shows value approaching the September relative price peak.

The U.S. dollar will also benefit from tax reform.

The U.S. stock market extended its outperformance versus the MSCI EAFE following the tax cut news. A stronger U.S. dollar has underpinned the move.

The U.S. market is also on the verge of breaking out versus emerging markets. Weakness in the Chinese market has weighed on emerging markets over the past week. Despite the drop in China, the chart remains in an uptrend. A look at the fundamentals warrants more caution. Chinese interest rates are rising as the government lowers credit growth and targets the shadow-banking sector.

Gold is likely to lose from tax reform. The Federal Reserve will hike rates as economic growth picks up and financial conditions ease, even as inflation remains relatively low.

Crude oil touched $59 a barrel before pulling back this week. United States shale oil producers could be the main beneficiaries of an extended cut. West Texas Intermediate crude weakened to $57 following the news. Oil-related equities spiked in early November, but have been down over the past two months.

The biotechnology sector continues to weigh on healthcare, but pharma and healthcare providers have rallied strongly this month. Medical devices remain the strongest subsector. UnitedHealth Group (UNH) lifted the provider subsector today after strong earnings and guidance for 2018.

Transportation stocks led the industrial sector to a new all-time high today. Defense shares are nearing a breakout.

Strong housing data sent iShares U.S. Home Construction (ITB) to another 52-week high. New homes sales jumped to an annualized pace of 685,000 in October, well above expectations and consistent with a robust economic expansion. Shares have gained 30 percent over the past three months.