- The S&P 500 Information Technology Sector is up over 35% YTD. The sector led all groups (again), rising 7.7% in October.
- October was a strong month for equities overall but four sectors saw declines, with seven advancing.
- Materials and Utilities outperformed the broader index, up 3.8 and 3.9% respectively.
- The weakest sector in October was Telecom Services with a decline of 8.7% (this sector consists of only three stocks and was hurt by AT&T's performance). Energy, Staples and Healthcare were also in the red.
- Large Caps performed better than small caps for the month while growth significantly beat value.
- The Nasdaq Composite is the best performing broad U.S. index YTD and closed October with its 62 nd record close for the year, tying a record set in 1980 for the most record closes in a year.
- Volatility remains low as measured by the CBOE Volatility Index (VIX) as markets moved higher.
- Inflation remains low but there are early indications this could pick up in 2018
The major equity indices were higher in October led by the Dow Jones Industrials and Nasdaq 100 with gains of 4.3% and 4.5% respectively. The Dow has seen positive returns in eleven of the last twelve months and finished October with a YTD gain of +18.3%. October was the fourth time in 2017 where the Nasdaq 100 gained more than 4% and YTD it leads all indices with a return of +28.5%. The S&P 500 gained a respectable +2.2% in October while the small cap Russell 2000 eked out a small gain of 0.8% as it apparently needed a breather following September's 6.1% gain.
Technology was once again the primary driver for equites with the S&P 500 Technology index gaining 7.7% in October. On the last Friday of the month, the technology index surged forward by its largest intraday move since March 1, 2016 after Amazon, Alphabet, Microsoft and Intel each posted strong Q3 results and guidance. Investor focus has shifted towards Apple which is set to release results on 11/2 as the equity is on its best 5-day winning streak in over a year. The surge higher was driven by analysts raising their demand expectations for the iPhone X, while the pull-back in September caused by weak iPhone 8 sales seems to be less of a concern.
The perception amongst investors is that the rally has been fueled by large-cap names but Andrew Garthwaite of Credit Suisse doesn't see it that way. Looking at the breadth between the S&P 500 and S&P 500 Equal weight, Andrew noted that the equal weighted index has only marginally underperformed over the past year (+23.5% vs +20%), which is drastically different from the Tech bubble where the large cap stocks greatly outperformed.
Note the light blue line on the chart below which depicts the Technology sector's weighting in the S&P Index. Tech has been the highest weighted sector since taking the reins from Financials in 2008. Its upward spike this year is notable. Tech now commands a 24% weighting in the S&P, second only to levels last seen during the dot.com era. This is approximately 10 percentage points higher than the approximate 14% weights for Financials and Healthcare, the #2 and #3 weighted sectors over the past 5 years. For smaller cap tech, however, the story is different. Though the S&P 600 Information Technology Index is up over 16% this year, small cap healthcare (25%) and utilities (19%) are outperforming this year. Industrials and Financials also have a higher weight in that index.
The consumer staples sector stood out for the wrong reasons with a loss of (1.6%). The group closed out the month with daily losses in nine of the final eleven sessions, and in the final week of the month it broke down below an important technical level. Rising yields and a strengthening dollar are recent headwinds that could persist throughout the remainder of 2017. From a technical perspective the group is deeply oversold and over the near term is due for a relief rally, however it is now marginally positive in 2017 with a YTD gain of 2.8%. There is a fair amount of overhead supply beginning at 551 that could weigh on the group in the weeks and months ahead.
The other laggard was the energy sector which spent most of October working off overbought technicals following September's robust 10% gain. After a strong showing in September the S&P Energy Index declined about 0.7% in October. That contrasts to the primary underlying commodity, crude oil, which is performing well and just posted the first back to back monthly advances this year. WTI crude gained 5.3% in October while Brent gained 6.7% and is trading above the $60 line for the first time since early July '15. Why the disconnect between crude and the equities? After all energy firms reported the strongest Q3 earnings growth of any sector through October 27 th , and in dollar terms Factset reports the sector earned $10.8b in Q3 compared to just $4.6b in 3Q16. However the forward PE for energy is 27.6, the highest of any sector.
The Financial Times reports that money flows are one of the factors pushing the markets higher. U.S. equities saw $14B of inflows over the last three weeks in October, the longest string since Q1. Investors continue to jump on equities, despite the climbing valuations. Bloomberg and Lipper data reach similar conclusions, but there is also an interesting trend in play. With the exception of international and emerging market, equity mutual funds are experiencing modest outflows while equity ETFs are receiving strong inflows. There has been a lot of talk lately about the shift to toward passive investing, and the money flow data backs it up.
According to FactSet's latest Earnings Insight report, the blended growth rate for Q3 S&P 500 EPS currently stands at 4.7%, better than the 3.0% expected at the start of the quarter. Of the 55% of S&P 500 companies that have now reported for Q3, 76% have beaten consensus EPS expectations, better than the 71% one-year average. In addition, 67% beat consensus sales expectations, well above the 61% one-year average. However, companies are reporting earnings that are 4.7% above expectations, below the 5.1% one-year average. Sales are running 1.5% above expectations, beating the 0.6% one-year average.
If you beat on earnings, your stock goes up, right? Not exactly. The WSJ analyzed earnings beats over the past 10 quarters prior to Q3'17. The percentage of companies that beat on earnings and saw a stock price increase was running somewhat north of 60% in 2015 and 2016. In the current quarter so far only a little more than half of companies, 55%, saw a price increase following an earnings beat. This is an improvement over the 49% that saw an increase last quarter. The percentage of companies that were punished for missing earnings is down from numbers approaching 80% in the past two quarters to just below 60% in the current quarter. Taken together, the numbers suggest sentiment is improving. Our view as to why these stats aren't higher: Earnings get priced in before a company's release, forward guidance is disappointing, or industry/market factors outweigh the company specific factors in an earnings release.
In October the Federal Reserve commenced its balance sheet reduction plan by reducing reinvestments from maturing securities by $10B a month. Each successive quarter this amount is expected to increase by $10B to a cap of $50B. This is considered a relatively gradual reduction to the Fed's $4.5T balance sheet, yet markets will be keenly focused on its impact on interest rates and the yield curve. Whereas rate hikes have a more direct impact on the short end of the curve, the reduction of the Fed's balance sheet should have a greater impact on long term rates. During the three rate hikes beginning in December 2016, the 2yr - 10yr yield curve flattened dramatically from 135 bps in December to 75bps. The flattening curve was due largely to the 45bps rise in the 2-yr yield in 2017, from 118bps to 163bps.
Now 75bps is an important support level for the 2yr - 10yr spread as it has been tested a number of times since last summer and marks the lowest the curve has been since the financial crisis in 2007. A break below this support could be followed by accelerating downside momentum which would be a concerning signal to the markets. Conversely reduced asset purchases along with healthy economic data could reverse the flattening seen throughout most of 2017. Of importance going forward is the long 10-yr Treasury yield which rallied from its YTD low of 2.02% in September, to a weekly high of 2.41% in October. It closed the month at 2.37% and below a key technical level. The 2.40% - 2.42% range has proven to be a firm resistance level over the lasts six months and the long yield may need to put in some work before it is ready to break out above this zone.
Annualized GDP for the 3 rd quarter showed the U.S economy grew at 3.0% (expected +2.6%), after a +3.1% in the 2 nd quarter, posting the best back-to-back growth since 2014. The recent hurricanes appeared to suppress some parts of the economy, while helping expanding other segments, mostly in consumer spending. The U.S. Economy is in its 9 th consecutive year of recovery, and economists are currently optimistic about the global recovery. There are limited signs of inflation on the horizon but the Fed believes this is transitory and is expected to hike rates this December and a few more times in 2018 based on the belief that low unemployment will eventually drive wage costs higher.
The upward shift in rates across the curve has been a tailwind for the U.S. Dollar which could persist throughout the remainder of 2017. The U.S. dollar Index (DXY) started off October with its worst yearly performance since 2003, however this weakness reversed in early September beginning with the lifting of the debt ceiling. Since then a number of developments, including optimism over tax reform as well as diverging central bank policy, have been a tailwind for the dollar. As the Fed embarks on its balance sheet reduction plan, the ECB just last week announced a dovish taper whereby it extended its asset purchase program by nine months while reducing the monthly purchases by 50% to €30B. The "surprise" was the ECB's accompanying dovish statement which stated rates will remain at current levels "well past" the end of QE. Accordingly European sovereign yields have been falling as U.S. rates are rising.
The spread between 10-yr German Bunds and US Treasuries, which has a 55% correlation to the US Dollar Index (DXY), has widened to 5-month highs last seen when then the US Dollar index was trading at 99.65, +5.5% from current levels. In the final days of October the dollar index made a bullish breakout from a common technical bottoming pattern and now appears poised for future gains. The strengthening dollar could act as a headwind for a number of assets including commodities, emerging markets, and large US multi-national corporations.
Looking ahead markets is expected to get the first concrete look at the administration's tax reform plan on November 3rd when the House Ways and Means Committee plans to release its initial tax reform bill. This version will be amended before it goes to the Senate which will have its own revisions. Some of the controversial provisions that will be up for debate include the deduction for state taxes, reducing the maximum contribution for retirement accounts, and eliminating the interest expense deduction for businesses.
The tax bill's progress will be widely watched by investors as some of the expected benefits are seemingly priced into equities already. The transition to a new Fed Chair, with longer term expected impacts of policy changes is also beginning to be discounted by market watchers, in addition to assorted geopolitical events like North Korea and developments in Europe that have faded to the background for the moment.
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Nasdaq's Market Intelligence Desk (MID) Team includes:
Michael Sokoll, CFA is a Senior Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing NASDAQ-listed companies with real-time trading analysis and objective market information.
Jeffrey LaRocque is a Director on the Market Intelligence Desk (MID) at Nasdaq, covering U.S. equities with over 10 years of experience having learned market structure while working on institutional trading desks and as a stock surveillance analyst. Jeff's diverse professional knowledge includes IPOs, Technical Analysis and Options Trading.
Steven Brown is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over twenty years of experience in equities. With a focus on client retention he currently covers the Financial, Energy and Media sectors.
Christopher Dearborn is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq. Chris has over two decades of equity market experience including floor and screen based trading, corporate access, IPOs and asset allocation. Chris is responsible for providing timely, accurate and objective market and trading-related information to Nasdaq-listed companies.
Annie O'Callaghan is Director on the Market Intelligence Desk (MID) at Nasdaq. Annie has worked for NASDAQ in a variety of roles including support of Nasdaq C-level management in client retention and customer service. Annie also served as a Sales Director in Nasdaq's Transactions Services business. Prior to joining Nasdaq, Annie worked at AX Trading, managing accounts for its Alternative Trading System and served on Credit Suisse's trading desk as an Electronic & Algorithmic Sales Trading Analyst.
Brian Joyce, CMT has 16 years of trading desk experience. Prior to joining Nasdaq Brian executed equity orders and provided trading ideas to institutional clients. He also contributed technical analysis to a fundamental research offering. Brian focuses on helping Nasdaq's Financial, Healthcare and Airline companies among others understand the trading in their stock. Brian is a Chartered Market Technician.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.