Tax Plan Unveiling, Weak Bond Market Front And Center Early On

A long awaited tax plan from Congress and a big drop in bond prices could be market catalysts Wednesday, even as investors continue to ponder yesterday’s words from Fed Chair Janet Yellen.

The big story today is likely to be the Republican tax plan, but first let’s check the bond market. Bonds fell sharply early Wednesday, with 10-year yields climbing five basis points to 2.29%. This could reflect reaction to comments from Yellen that some interpreted as hawkish, as well as what appears to be a growing appetite among investors to embrace riskier assets.

Yellen seems worried about the Fed getting behind the curve if a healthy labor market starts pushing up inflation before the Fed can tighten policy enough to deal with it, but at the same time ponders the possibility that low inflation could reflect a changing economy and require the Fed to take a more gradual approach. She said the Fed might have “misjudged” the various forces keeping prices down.

The Fed chair has been pretty open discussing the Fed’s confusion over what she calls the “mystery” of lower inflation. Once again Tuesday, she said whatever the cause, it’s probably transitory and inflation is likely to get back to the Fed’s 2% goal. She warned of the danger of “moving too gradually” and said there’s no reason to wait on hikes until 2% becomes reality. People read this as slightly hawkish, and most investors appear convinced that one more rate hike is on the way by the end of the year. CME Group Fed funds futures indicate a nearly 80% chance, and that could be what’s ailing bonds this morning.

We’ll get another read on inflation this Friday when August Personal Consumption Expenditures (PCE) readings come out. As a reminder, core PCE prices rose just 1.4% in July from a year earlier. On the data side today, durable goods orders rose 1.7% in August, well above Wall Street’s expectations.

St. Louis Fed President James Bullard is scheduled to speak today, so keep an eye out for that.

Tax reform seems like it’s been coming for months, but this afternoon is when more details could hit the wire. Some of the key things to look for from a market standpoint include where the corporate tax rate might be, any plans for tax repatriation, and the top rate for individuals. Any word today is likely to be just a framework and not too detailed, but there is a sense of curiosity among investors as to what that framework might look like.

Earnings season is still some time away, but the vanguard came into view as Dow component Nike (NKE) reported mixed results. Shares fell despite NKE beating Wall Street analysts’ earnings estimates, as some investors seemed disappointed by the revenue number despite revenue slightly beating expectations. Pressure on NKE could weigh on the Dow Jones Industrial Average ($DJI), which fell in late trading yesterday and is down four days in a row.

From a sector standpoint, info tech recovered a bit Tuesday after its recent slide, and still leads all sectors in gains since Jan. 1. That said, info tech looks a little tired on the charts, having barely kept up with the broader market over the last three months and gaining just 0.3% over the last month. The one-month sector leaders include energy (up nearly 10%), industrials (up 5.5%), and materials (up 4.6%). Financials have also outpaced the S&P 500 (SPX) since late August.

In a way, it’s kind of healthy to see this shift in sector leadership from info tech toward other cyclical names. If the shift was into defensive sectors like healthcare, utilities, or consumer staples, than it might be a different story. Instead, it appears there may be some sector rotation out of tech but into aggressive sectors that investors tend to favor in a strong economy. Small stocks have also been rallying (see below).

None of this is to say info tech’s run is over. The sector has shown resiliency this year after falling sharply a couple of times. However, the steep gains it reeled off in early 2017 definitely seem harder to come by lately. Maybe earnings next month can provide a possible catalyst, especially with a weak dollar potentially helping info tech sales into overseas markets.

FIGURE 1: DJIA IN A RUT The Dow Jones Industrial Average ($DJI) has posted its first four-day losing streak since June, as seen in this five-day chart. At the same time, the Russell 2000 (RUT) index of small stocks, represented by the purple line, has soared to new all time highs as investors seem enticed by smaller names. Data source: Dow Jones, FTSE Russell. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Set Your Clocks for GDP

Earlier this week, we noted that the Atlanta Fed’s GDP Now web site had dialed back its estimate for Q2 gross domestic product to a rather tepid 2.2%, down from its 4% estimate at the start of August. It was also light compared to the government’s most recent estimate of 3% growth. Checking Wall Street analysts’ estimates for tomorrow morning’s final Q2 GDP figure, things look a little brighter. On average, analysts expect GDP growth of 3%, according to Briefing.com. That would mean no change from the previous government estimate and continue to signal moderate economic growth, if analysts are correct. Last time out, the government cited a pickup in consumer and business spending during Q2, so we’ll see if that continues. The numbers are due out at 8:30 a.m. ET Thursday, and sometimes can move the market if they’re far from expectations.

Russell on a Roll

The Russell 2000 (RUT) small-stock index continued to ring up new all-time highs early this week, eclipsing its previous highs set over the summer. Considering the weak dollar that’s been helping major multinationals recently, it may seem a bit ironic that small stocks — which typically rely less on exports — are doing so well. One reason might be that info tech stocks, which came under pressure recently, represent only a small portion of the RUT. It’s also possible that with other major indices already up double digits for the year, some investors are looking for markets that might have a longer runway. With RUT up just 7% year to date compared to an 11.5% rise for the S&P 500 (SPX), perhaps it looks more inviting.

Thanks, Greenback

Speaking of exports, U.S. companies with a big overseas presence are up more than 19% so far this year, compared with a 4.5% return for companies that get 90% of their revenue within U.S. borders, USA Today reported. That might help explain why small stocks in the RUT haven’t done as well as big ones in the SPX and Dow Jones Industrial Average ($DJI). With the dollar still near its yearly lows despite a small rally this week, we could be getting an inkling of what to expect when Q3 earnings rolls around next month. Look for the big multinationals to potentially see continued benefit from the weak dollar, a trend that could benefit the industrial and info tech sectors, in particular. We’ll soon be sharing some sector-by-sector Q3 earnings growth estimates, so stay tuned.