Many equities rebounded over the past month, with Internet companies pushing the Nasdaq-100 to a new all-time high. Strong jobs data from October and a more hawkish Federal Reserve caused a reversal in interest rate expectations. This in turn pushed the U.S. dollar near its highs for the year. However, weaker sales in the retail sector put a damper on the market, causing the S&P 500 Index to lose 0.04 percent over the past month.
October saw 276,000 new jobs added in the United States, higher than expectations and enough to lower the unemployment rate to 5 percent. There are only a few important data points left to be reported before the Fed makes a decision at its mid-December meeting, so unless there are negative data surprises, the Fed is on track to hike rates in a few weeks.
Incoming economic data has been generally strong across the board. Wholesale inventory data for September was stronger than expected, which should lead to an upward revision of third-quarter GDP. The initial estimate, reported in October, was 1.5 percent growth. As for the current quarter, the Atlanta Federal Reserve’s GDP Now model currently forecasts 2.3 percent growth, thanks to rising forecasts for consumer spending and fixed asset investment.
However, The Wall Street Journal reported that imports at the three busiest ports in the U.S. fell in September and October. The business inventory-to-sales ratio is at its highest level since the early 2000s and retail inventories are up, but the number has been rising since 2012 without any effect on the wider economy. Furthermore, the Journal also reports that both FedEx (FDX) and Amazon (AMZN) expect strong holiday seasons, which points to weakness for brick-and-mortar retailers. Nevertheless, manufacturing is affected much earlier as orders slow, and as of yet, we have not seen signs of a manufacturing slowdown.
Where weakness is showing is in China. A check of industrial commodities tells the story: coal, iron ore, steel, aluminum, copper and oil are trading at lows unseen in at least five years, and most have hit new 52-week lows over the past few weeks. Despite interest rate cuts and stimulus efforts, industrial production growth in October was at its 2015 low, while real estate and fixed asset investment continued to slow and deflationary pressures mounted. Many Chinese steelmakers are dumping steel onto the world market at a loss, but they continue to produce in order to maintain cash flow and avoid bankruptcy. This is delaying the day of reckoning for the industry, as well as the final washout bottom in the industrial commodities. Further interest rate cuts and stimulus efforts will likely be announced in the coming weeks.
China is likely to see positive press, due to the expected inclusion of the yuan into the International Monetary Fund’s Special Drawing Rights (SDR) basket of currencies. This has been a much-hyped move that will have little to no impact on global finance beyond any reforms that China must assent to as a condition of the yuan’s inclusion. The addition of the yuan to the SDR basket doesn’t require central banks to buy yuan, nor does it make yuan-denominated assets more attractive to investors.
Earnings season has been mixed for stocks. More than 90 percent of companies have reported thus far and 74 percent have beaten earnings estimates, but only 45 percent have beaten their revenue estimates. As noted, the retail sector was surprisingly weak, and guidance for the fourth quarter has been lowered for the broader consumer discretionary sector as well. Currently, 17 consumer discretionary companies have issued downward guidance for the fourth quarter, while none have increased expectations. Consumer discretionary is still far ahead of the energy sector though, which, despite reporting better-than-expected earnings in many cases, is still forecast to see earnings fall more than 60 percent. Energy earnings year-over-year won’t improve until the first quarter of next year. By January 2015, oil was trading in the $40 range, not far from where it trades today. A year ago today, however, oil was still near $80 a barrel.
One sector seeing its fortunes improve is the financial sector. SPDR KBW Regional Banking (KRE) gained 5.3 percent in the past month, with all the gains coming over the course of a couple of days. Hawkish comments from Fed Chair Yellen, plus the strong October jobs report, pushed the fund up 4.7 percent in only two days. That move left the fund at a new 52-week high. If the Fed does hike rates in December, the financial sector stands a good chance of becoming a market leader, challenging healthcare and technology.
Along with financials, the U.S. dollar has also performed well. WisdomTree Bloomberg U.S. Dollar Bullish (USDU) is already at a new high, and the more widely followed U.S. Dollar Index, tracked by PowerShares DB U.S. Dollar Index Bullish Fund (UUP), is less than 1 percent away from its high. In addition to raising rate hike expectations, European Central Bank President Draghi has been talking as though more quantitative easing is on the way. Recently, Japan’s economy slipped back into a technical recession, leading investors to sell the yen versus the U.S. dollar in anticipation of further quantitative easing from the Bank of Japan. If those central banks decide to act, it will be positive for currency-hedged ETFs such as WisdomTree Europe Hedged Equity (HEDJ) and Japan Hedged Equity (DXJ).
The Fed’s December decision likely won’t have a significant effect on the market beyond a few limited sectors, such as financials on the positive side and utilities to the downside. The U.S. dollar appears likely to break out and commodities appear headed lower, regardless of which way the Fed moves. The U.S. economy is on solid footing, and that will favor shares paying a good dividend. A stronger dollar will favor currency-hedged foreign ETFs, while weakness in China will weigh on commodities.