If you didn’t watch closely, you might have missed the stock market’s downdraft last week. It was that quiet. Shares pulled back about 0.5% in slow, summer-level trading levels.
Admittedly, there was a dearth of market-moving economic data releases. But not even an uptick in political rhetoric from North Korea was enough to push the market out of tight daily trading ranges. A rise in 10-year Treasury yields to as high as 3.12%, at one point from below 3% last week, was the main bearish impetus for equity traders. The yield settled at 3.07%.
The Dow Jones Industrial Average dropped 116 points, or 0.5%, to 24,715.09. The Standard & Poor’s 500 index also lost 0.5%, or 15 points, to 2712.97. The index kept to a 10- to 20-point daily trading range, much tighter than in prior weeks. The Nasdaq Composite gave up 0.7% to finish at 7354.34.
With the first-quarter earnings cycle out of the way, there isn’t much new for equity investors to focus on beside yields, says John Leo Manley, a Wells Fargo investment strategist. This Wednesday sees the release of minutes from the last Federal Open Market Committee meeting. The market, he says, is looking for another rate hike in June.
A generally bullish Jeremy Klein, chief market strategist at FBN Securities, adds that as long as rates “move up in an orderly way, not in a sprint,” the strong equity-market fundamentals will allow stocks to move higher.
Despite increasing concerns about interest rates, small- capitalization stocks, as measured by the Russell 2000 index, hit a record last week, at 1626.63. Some bulls take that to be a harbinger of better things to come from large-caps. Maybe it is, and maybe it isn’t. We’ll get to that in a moment.
Energy stocks, up 1.5% last week, continued to rally on stronger oil prices. Meanwhile, consumer staples remain, among strategists, the most hated group in the universe. Valuations remain high and earnings growth low. Staples is one of just two sectors where estimates are dropping for both 2018 and 2019 earnings growth, the other being telecoms. As bond proxies, both are suffering as interest rates go up. Staples are down 14% in 2018, telecoms are off 13%.
Bulls claim that last week’s rise in small caps will herald a rise in the rest of the market. It’s a sign of “risk on” for the whole stock market. But that isn’t supported by the technical data, says Doug Ramsey, chief investment officer of the Leuthold Group, who measures the relative strength of the Russell 2000 index compared to the S&P 500. Since 1979, when this ratio is above its 40-week moving average, as it is now, the S&P 500’s return is an annualized 4.2%. That’s one-third of the 12.9% return when the ratio is below the moving average.
Moreover, as recoveries go, this one since the Feb. 8, 2018 low is getting long in the tooth. As of Friday, says Ramsey, “we are 69 trading days from the low” without recovering to a new high. For stock market drops of 7% to 12% since 1950—the 2018 correction was 10%—the median time to recover is 33 days.
What’s taking so long? Fundamentals are strong, right? Our guess is that a good portion of those improvements—such as supercharged earnings growth—was anticipated and baked into to the high reached Jan. 26. Maybe the market wants something else.
