Schwab Live: Trader’s Outlook for August 18, 2017: Larger market pullback appears likely

Weekly Market Review:

If you read last week’s blog, you know that I liked the technical set up heading into this week and my outlook was bullish. My forecast looked like it was on track by mid-week (SPX +1.5% at the intraweek high mark) but things started going south mid-day Wednesday following President Trump’s announcement that he is ending both the manufacturing council and Strategic Advisory Forum. The decision came after multiple CEOs voiced objection towards how the President responded to violence that erupted in Charlottesville over the weekend. Equity markets experienced the second worst sell-off of the year on Thursday following critical commentary from Republican Senator Bob Corker (stating Trump lacks the stability, competence or understanding of the country’s character to succeed) and a rumor that Gary Cohen may resign from the administration (later denied by the White House). Add it all up and it appears that investors are concerned about the deterioration of Trump’s relationship with big business which may affect the administration’s ability to make good on the economic initiatives that were promised earlier in the year:    

Source: Schwab StreetSmart Edge®

Probability of Fed Rate Hike (8/18/17):

This week’s volatility in the equity markets has translated into volatility in Bloomberg’s rate hike probability from the Fed. It’s apparent that markets have essentially taken a September or November rate hike off the table recently so the focus moves toward this year’s December FOMC meeting. The probability of a December hike closed at 33% last Friday, hit an intraweek high of 43% onTuesday (largely driven by strong economic data) but has dropped all the way to 25% at the time of this writing:

Source: Used with permission of Bloomberg Finance L.P.

This Week’s Notable 52-week Highs:

Apple Inc. (AAPL + $1.16 to $159.02)

Altaba Inc. (AABA + $1.30 to $63.50)

Alibaba Group Holdings Ltd. (BABA + $4.48 to $168.40)

Cigna Corp. (CI - $0.53 to $177.50)

Hartford Financial Services Group Inc. (HIG - $0.25 to $55.35)

Kansas City Southern (KSU - $0.08 to $105.79)

Kite Pharma Inc. (KITE + $3.00 to $129.03)

Pepsico Inc. (PEP - $0.79 to $117.60)

Pultegroup Inc. (PHM + $0.01 to $25.45)

Salesforce.com Inc. (CRM + $0.08 to $90.96)

Weibo Inc. (WB + $0.86 to $89.18)

Waste Management Inc. (WM - $0.04 to $75.48)

Q2 Earnings Season

Roughly 92% of the S&P 500 companies have released their Q2 earnings reports and so far 73% have beat analyst’s EPS estimates while 68% have beat on the top line. Compared to Q1 results the EPS beat is lower (73% vs. 78%) but revenue is tracking higher (68% vs. 63%). Here are some of the key earnings reports that came out this week:

 

 

The tail end of Q2 earnings season is winding down but there are still some relatively high-profile names that will be reporting next week:

Monday: NDSN, BZUN

Tuesday: MDT, TOL, DSW, CRM

Wednesday: LOW, HP, PVH, WSM, GES

Thursday: TIF, SJM, AVGO, ADSK, ULTA, MRVL, GME

Friday: --

Volatility:

Last Friday the VIX hit a year-to-date high of 17.28 (at least on an intraday basis) but ended up closing at 15.51 and dropped all the way into the 11’s earlier this week. It appeared that the volatility spike was going to be another short-lived phenomenon but we saw another flare-up this week. No doubt the volatility has been driven by this week’s political turmoil and It’s impossible to say where we go from here but higher uncertainty and more frequent spikes isn’t an encouraging sign, especially given the seasonally weak period for the markets that we’re in (August and September are the first and second worst performing months for the markets historically):

Source: Schwab StreetSmart Edge®

Technical Outlook:

S&P 500 Index ($SPX): As mentioned in the review section the SPX experienced its second largest one-day drop of the year yesterday and touched a one-month low of 2,420 earlier this morning, but has moved into positive territory by mid-day today which was largely fueled by news that White House Chief Strategist Steve Bannon has resigned from the administration. While the intraday reversal in the SPX is an encouraging move for the bulls there are still some orange flags that have showed up on the map recently. First, the index made a new all-time high last week but reversed course intraday and ended up closing lower. Secondly, it appears that the index put in a lower successive high on Wednesday, though it may be a little early to make that determination. Third, the index closed back below its 50-day simple moving average (SMA) yesterday. Finally, the index is pressing up against the lower end of its upward trending channel so it will be critical to see how it closes today and what the follow-through action looks like on Monday:

Source: Schwab StreetSmart Edge®

NASDAQ Composite ($COMPX): The NASDAQ is in a similar situation as the SPX as two potential lower highs have been established this month (marked by the two small blue arrows in the chart below), the index has dropped back below its 50-day SMA and it is also pushing up against the bottom of its upward trending channel. I think it’s setting up for a break-out test next week, meaning the index is likely going to move significantly either to the upside or downside and I’m feeling more cautious than optimistic about where it currently stands:

Source: Schwab StreetSmart Edge®

Russell 2000 ($RUT): The technical condition of the Russell 2000 deteriorated even further this week as the index successfully bounced off its 200-day SMA early in the week but then reversed and closed below it yesterday. This sets the small-cap index up for a critical test of the 1,350 level which has proved to be support multiple times this year (marked by the small green arrows below):

Source: Schwab StreetSmart Edge®

Economic Recap:

There were numerous economic data points that came out this week and there was definitely a strong bullish-bias to the set. Notice how many reports registered multi-month highs in the “Key takeaways from this week’s data” below. Let’s walk through the individual reports:

Better than Consensus Estimates:

  • Business Inventories:+ 0.5% vs. 0.4% est
  • Empire Manufacturing: 25.2 vs. 11 est
  • NAHB Housing Market Index: 68 vs. 65 est
  • Retail Sales +0.6% vs. 0.3% est
  • Retail Sales (ex-auto): +0.5% vs. 0.3% est
  • Initial Jobless Claims: 232K vs. 242K est
  • Philadelphia Fed: 18.9 vs. 16 est
  • Michigan Sentiment (Preliminary): 97.6 vs. 93 est

In-line with Consensus Estimates:

  • Capacity Utilization: 76.7% vs. 76.7%
  • Leading Indicators: 0.3% vs. 0.3%

Worse than Consensus Estimates:

  • Building Permits: 1,223K vs. 1,255K est
  • Housing Starts: 1,155K vs. 1,229K est
  • Industrial Production: 0.2% vs. 0.4% est

Key takeaways from this week’s data:

  • Business Inventories (+0.5%) increased by the largest amount in 7 months.
  • Empire Manufacturing registered its highest reading (25.2) in nearly three years.
  • July Retail Sales (+0.6%) showed the largest jump since last December (+0.9%).
  • The Philadelphia Fed Manufacturing index (18.9) has been in positive territory for 13 straight months.
  • Michigan Sentiment registered its highest read in seven months.

Here’s a look at next week’s line-up:

  • Monday (14th): --
  • Tuesday (15th): FHFA Housing Price Index
  • Wednesday (16th): Crude Inventories, MBA Mortgage Application Index, New Home Sales
  • Thursday (17th): Initial Jobless Claims, Continuing Claims, Existing Home Sales, Natural Gas Inventories
  • Friday (18th): Durable Goods, Durable Goods (ex-transportation)

Next week’s economic data set will be a lot lighter which means that the political headlines will likely garner even more attention from traders. However, out of all of the reports I think Wednesday’s crude inventories report (given the technical breakdown in energy stocks recently) and the durable goods report on Friday have the most potential to move markets.

Summary:

Political uncertainty, market seasonality and technical break-down point to a bearish outlook next week.     

Equity markets are off the lows of the day, but also off the highs that were hit roughly an hour ago at the time of this writing (1:42 PM ET) as the Dow Jones Industrial Average (DJI) is down 10 to 21,740, the NASDAQ Composite (COMPX) up 10 to 6,232 and the S&P 500 (SPX) up 2 to 2,432. Markets received a bullish boost late-morning following news of Steve Bannon’s resignation but now it appears that investors are selling into that rally which is not good price action from a technical perspective. The heightened uncertainty in the White House and the technical damage that occurred this week is concerning in my opinion. Add in the fact that we haven’t seen a correction of more than 3% in the markets this year and we are in the weakest period for the markets from a seasonal perspective (August and September are the first and second worst performing months historically) and that’s enough for me to raise the caution flag. It’s possible that markets rally back from this week’s pullback (as they have multiple times in the past) but I think the odds favor the downside and therefore have a bearish outlook for next week.

 

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Important Disclosures

Past performance is no guarantee of future results. 

Schwab does not recommend the use of technical analysis as a sole means of investment research. Past performance is no guarantee of future results. Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss.