Schwab Live: Trader’s Outlook for May 19: Stocks recover from mid-week selloff

Weekly Market Review:

Equity markets are rallying for the second day in a row as investors appear to feel more comfortable about the potential fallout from a New York Times report that suggested recently fired FBI Director James Comey was asked by President Trump to stop an investigation into Michael Flynn’s ties with Russia. Following the report, equity markets experienced their biggest one-day decline of the year on Wednesday as the SPX lost 43 points or 1.8%. It’s worth noting that prior to Wednesday’s sell-off the SPX hit a fresh all-time closing high of 2402.32 on Monday and a new intraday high of 2405.77 on Tuesday: 

Source: StreetSmart Edge®

Probability of Fed Rate Hike (5/19/17):

This week’s political snafu and subsequent market volatility sent Bloomberg’s World Interest Rate Probabilities on a ride but as of this writing the current probability of a Fed hike in June ended the week where it began. On Wednesday the probability of a June hike dropped all the way down to 86% but is back up to 97.5%, suggesting that market participants feel confident that the Fed is on track to make a move next month:

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

This Week’s Notable 52-week Highs:

Adobe Systems Inc. (ADBE + $1.96 to $136.50)

Alibaba Group Holding Ltd. (BABA + $3.75 to $125.04)

Amazon.com Inc. (AMZN + $7.94 to $966.43)

American Tower Corp. (AMT + $0.45 to $128.43)

Apple Inc. (AAPL + $1.05 to $153.59)

Applied Materials Inc. (AMAT + $0.42 to $44.33)

Autodesk Inc. (ADSK + $14.77 to $110.60)

Deere & Co. (DE + $8.54 to $121.21)

Diago PLC (DEO + $0.76 to $120.79)

Electronic Arts Inc. (EA + $0.44 to $107.37)

KB Homes Inc. (KBH + $0.35 to $21.34)

McDonald’s Corp. (MCD + $1.71 to $148.72)

NVIDIA Inc. (NVDA + $3.08 to $136.15)

Netflix Inc. (NFLX + $1.60 to $157.30)

Sony Corp. (SNE + $0.26 to $35.58)

Wal-Mart Stores Inc. (WMT + $1.34 to $78.88)

Xilinx Inc. (XLNX + $1.21 to $66.82)

Volatility:

Volatility has been subdued for most of 2017 but that changed on Wednesday as investors scurried to establish downside protection and pushed the VIX up by nearly 50%. Wednesday’s spike was the biggest of the year and the move followed last week’s 10-year intraday low of 9.62. However, as of this writing the VIX has given back roughly 80% of Wednesday’s gain due to the market recovery which has taken place over the past two days:

Source: Schwab StreetSmart Edge®

Technical Outlook:

S&P 500 Index ($SPX): As mentioned in the review section above, the SPX hit a new all-time closing and intraday high earlier in the week but the manner in which these highs were established were lackluster. What I mean is that Monday’s new all-time closing high of 2,402.32 surpassed the old closing high of 2,399.63 by less than three points and there was no follow-through on Tuesday. On a positive note, the SPX decidedly closed below its 50-day SMA on Wednesday but took little time to rally back above it. While I’m not sure where we go from here, I would peg the 50-day SMA (currently 2,369) as near-term support and feel that there’s a good chance that we return to a slow grind higher like we have had for most of May:    

Source: Schwab StreetSmart Edge®

NASDAQ Composite ($COMPX): The NASDAQ has been a relative outperformer this year (2X the % return of the SPX YTD) and the tech-heavy index registered a fresh all-time closing high of 6,169.87 on Tuesday. While the NASDAQ also suffered a bigger decline on Wednesday’s sell-off (-2.56% vs. -1.82% for SPX) it has recovered the bulk of that drop since then. Given that technology has been a leadership group it will be important to monitor the COMPX in the coming weeks to see if it continues to attract money flow and outperform the other indices (which would be a healthy sign for the bulls):

Source: Schwab StreetSmart Edge®

Russell 2000 ($RUT): Out of the four major U.S. indices the Russell 2000 looks the worse technically speaking. It has been a relative underperformer during the month of May and it is the only index out of the four that remains below its 50-day SMA. Ideally, the bulls would like to see all of the major indices hitting all-time highs concurrently (indicating broad participation) but the RUT failed to do so this month and remains roughly 3% below its all-time intraday high of 1,425 hit back on April 26th (note: the DJI also failed to establish a fresh high this month). For now, the key near term levels to monitor are the 1,340 support level and the 50-day SMA which is currently 1,377:

Source: Schwab StreetSmart Edge®

Dow Jones Transportation Average ($DJT): The DJT hit a fresh 2017 low of 8,744 yesterday which isn’t a bullish indicator, especially if you are a “Dow Theorist”, but on a positive note the index found support at its 200-day SMA (currently 8,743). However, I’ll be monitoring this index in the coming weeks to see if we get a retest of the 200-day and will move to a cautious stance if we close below it:  

Source: Schwab StreetSmart Edge®

U.S. 10-Year Treasury Yield ($TNX): I don’t have a good explanation as to why interest rates have been moving lower when it appears that a Fed move in June is highly likely. In any event, I think the bulls would like to see rates higher than where they are currently, as a gradual rise is typically associated with economic expansion. Earlier this month it looked as if yields were back on the move higher but this week we broke through (prior) support at 2.30% so 2.20% becomes the level to watch in the near-term:

Source: Schwab StreetSmart Edge®

Economic Recap:

The economic data was on the light side this week and the reports were pretty much a mixed bag of results. A couple of housing reports missed expectations pretty badly but employment data remained strong and a robust Philadelphia Fed report countered a soft Empire Manufacturing report. Let’s walk through the individual reports:

Better than Consensus Estimates:

  • NAHB Housing Market Index: 70 vs. 68 est.
  • Capacity Utilization: 76.7% vs. 76.2% est.
  • Industrial Production: 1.0% vs. 0.3% est.
  • Initial Jobless Claims: 232K vs. 240K est.
  • Philadelphia Fed 38.8 vs. 18.5 est

Worse than Consensus Estimates:

  • Empire Manufacturing Index: -1.0 vs. 7.5 est.
  • Building Permits: 1229K vs. 1270K est.
  • Housing Starts 1172K vs. 1255K est.
  • Leading Indicators: 0.3% vs. 0.4% est.

Key takeaways from this week’s data:

  • The 38.5 read on the Philadelphia Fed is slightly below the 43.3 registered back in February of this year, which represented a 33-year high for the index
  • The Empire State manufacturing survey dropped into negative territory for the first time since November
  • Housing Starts dropped for the second straight month and the 1172K figure represents the lowest level in five months

Here’s a look at next week’s line-up:

  • Monday (27th): --
  • Tuesday (28th): New Home Sales
  • Wednesday (29th): Existing Home Sales, FHFA Housing Price Index, MBA Mortgage Purchase Index,      Crude Inventories
  • Thursday (30th): Initial Jobless Claims, Natural Gas Inventories
  • Friday (31st): Durable Goods, Q1 GDP – Second Estimate, GDP Deflator – Second Estimate, Michigan Sentiment

It looks like we will have a decent amount of data points to keep an eye on next week and there are a couple important ones that I’ve highlighted above. The housing data will not be as important as the Second Estimate for Q1 GDP on Friday, but given the recent misses on housing data I think investors might pay more attention this round. Back on April 28th we got our first read on Q1 GDP and it come in at a paltry 0.7% so I think market participants will likely be expecting an upward revision next Friday.

Summary:

Price action indicates that investor demand for equities remains high. Although headline risk is a valid concern, it’s likely that bullish momentum will continue in the near-term.     

Equity markets are trading near the highs of the day at the time of this writing (2:04 PM ET) as the Dow Jones Industrial Average (DJI) is currently up 175 to 20,838, the NASDAQ Composite (COMPX) up 46 to 6,101 and S&P 500 (SPX) up 21 to 2,386. Wednesday’s sell-off appeared to be driven by concerns that recent political turmoil could potentially delay many of the reform initiatives proposed by the Trump administration. However, investors either reassessed the situation or took comfort in Secretary Treasury Steven Mnuchin’s testimony in front of the Senate Banking Committee yesterday (he indicated that tax reform could be accomplished in 2017). Regardless, it appears that investor confidence and demand for equities remains high given the price action over the last two days. I think that there are odds of higher volatility (relative to 2017) in the near-term but I feel that it’s likely that we will see continued upward momentum into next week. Therefore, there will likely be more intra-week gyrations but my overall outlook for next week is “slightly bullish”. 

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