State of the Stock Market Analysis for the Week Ending on October 7th, 2018 (Sharp Rise in Treasury Yields 10-07-18)

 

All You Need Is Jobs

 

When the Dow hit its all-time high on Tuesday, not many investors would have thought that the major indices would end the week in the red. However, later that day, Fed Chair Jerome Powell gave a slightly hawkish speech, and that, together with the better-than-expected economic releases lead to a sharp rise in Treasury yields. This, in turn, triggered the deepest correction in stocks since August. Small-caps have been signaling a correction for two weeks, as the Russell 2000 continued to lead the way lower, together with the Nasdaq. The tech benchmark is almost 5% below its recent high, but bulls shouldn’t forget that the leading index lost the most during the previous corrections this year, which turned out to be great buying opportunities.

 

It was a truly historic week for Treasuries, with yields hitting multi-year and decades-long highs across the curve. The U.S.-Canadian-Mexican trade deal, the continued economic boom, and Mr. Powell’s comments regarding inflation were all crucial for the “perfect storm” in yields, and now longer-dated yields even outpace the short-end of the curve. Before Friday’s government jobs report, the great ISM non-manufacturing PMI made the biggest waves, as it confirmed the strong expansion in the services segment, while the manufacturing PMI also showed healthy growth. The jobs report was slightly worse-than-expected, with payrolls missing the consensus estimate by a hefty margin. However, the unemployment rate fell to a 47-year low, and hourly earnings met expectations, which helped to cool inflationary fears.

 

The technical picture shows strong short-term divergences between the major indices after the volatile week. The Nasdaq fell below its 50-day moving average, the Dow remained well above its short-term indicator, while the S&P 500 closed the week just above its 50. All three of the benchmarks are still well above their steeply rising 200-day moving averages, with the bullish long-term trend still not in danger. The relatively weak Russell 2000 plunged all the way to its long-term moving average on Friday, and on a negative note, its 50-day moving average also turned lower in the second half of the week. The Volatility Index (VIX) reflected the risk-off shift as well, spiking to 17, the highest level since early June, before closing the week just above 15.

 

The weakness in market internals that preceded the selloff is still apparent, but from a broader perspective, the majority of the most reliable measures are still consistent with a healthy bull market. The Advance/Decline ratio fell to its lowest level since early July, as declining issues outnumbered advancing stocks by a 3-to-2 ratio on the NYSE, and by a 3-to-1 ratio on the Nasdaq. The average number of new 52-week highs fell for the third week in a row on both exchanges, edging lower to 53 on the NYSE and 55 on the Nasdaq. The number of new lows more than doubled in the meantime, rising to 275 on the NYSE and 145 on the Nasdaq. The percentage of stocks above their 200-day moving average declined significantly, hitting 42% on Friday, with the weakness in small-caps hurting the indicator again.

 

The most-shorted issues declined together with the broader market, and the notable deterioration in investor sentiment caused an uptick in short interest on Wall Street. Diamond Offshore (DO) stood strong amid the broad selloff, and with its days-to-cover (DTC) ratio still at 17, it could be among the first stocks to take off following the correction. Sempra Energy (SRE) also sports a high DTC ratio of 13, and after a year of choppy price action, the stock might be ready to test its record high. Gogo Inc. (GOGO) is up so far this month, in the face of the ongoing correction, and given the stock’s short interest of 61%, it could be in for a full-blown short squeeze.

 

Inflation will be at the center of attention this week, especially following Jerome Powell’s cautionary words, with the PPI and CPI indices coming out on Wednesday and Thursday, respectively. The rest of the week will be relatively quiet as far as economic releases are concerned, since only the Michigan Consumer Sentiment Index is scheduled for Friday. We will keep a close eye on Treasury yields after the past week’s steep rise, but Friday’s late-session bounce could be a sign that the worst is behind us. That said, a higher-than-expected CPI reading could revive inflationary worries, while the political field could get even more heated, with the mid-terms getting closer. Stay tuned!

 

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