Surge In Gap Shares, Trade Deal Optimism Help Boost Market Sentiment

The main pendulum between market optimism and pessimism continues to be developments in trade negotiations between China and the United States. And this morning it appears to have swung to the bullish side.

The hopefulness comes after a Bloomberg report said U.S. officials are working up a final trade deal that the two sides could sign in a matter of weeks.  

The news appeared to help Asian shares overnight along with news that a global index provider will increase the weighting of mainland China shares it its global benchmarks. Meanwhile, European shares stepped on the gas with help from the auto sector.

Back on this side of the pond on Thursday, the S&P 500 (SPX) and Dow Jones Industrial Average ($DJI) faltered for the last three sessions of February, but still managed to post gains for the second month in a row. The Nasdaq (COMP) also closed out the month higher.

It’s a stark contrast to the close of last year when stocks were under pressure because of fear the Fed would raise interest rates too much and worries about the U.S.-China trade war. (See more on the change in market circumstances below.)

Trade War Remains in Focus

While the Fed’s apparent pivot away from interest rate hikes has been a load off for the market. Concerns about the trade war between the world’s two largest economies have continued, with recent optimism fading a bit. 

On the one hand comments to CNBC from White House economic advisor Larry Kudlow and Treasury Secretary Steven Mnuchin were positive on progress on the talks. And the U.S. is going to take steps to formally abandon plans to increase tariffs on $200 billion of Chinese goods to 25%, from 10% now, while the two sides continue talking, The Wall Street Journal reported. 

But a counterpoint to that bullish news flow seemed to be U.S. Trade Representative Robert Lighthizer’s comments to Congress that China buying more U.S. goods isn’t a strong enough catalyst for a permanent trade deal to end a situation that has been weighing on the market for months. 

The U.S. government reported stronger-than-expected gross domestic product on Thursday, andthe delayed reading on Q4 GDP showing the economy grew 2.6% during the quarter when many analysts had expected 2% or even less, probably helped to counter the pressure from unease about the trade situation.

The U.S./North Korea summit ending without a deal amid disagreement on U.S. sanctions also appeared to weigh on the market.

Inflation Watch

Ahead of inflation data out this morning, Federal Reserve Vice Chairman Richard Clarida said the central bank isn’t altering its 2% inflation target. Fed Chairman Jerome Powell said Thursday evening that rising productivity means wage growth isn’t producing problematic inflation. He reiterated that inflation appears “muted.” 

The comments come ahead of today’s core Personal Consumption Expenditure (PCE) data, which is the Fed’s preferred inflation gauge. Core PCE rose a bit more than expected, coming in at 0.2% for December when a 0.1% gain had been expected in a Briefing.com consensus. 

Separation Gap

In corporate news Gap Inc GPS said the company is heading toward a split into two separate entities, with Old Navy being spun off into its own company. Investors appear to be loving the idea, with GPS shares up around 20% in pre-market trading. 

The move may allow the Old Navy brand to flourish on its own and management at the other company to focus on shoring up the Gap brand.

GPS also said it would close more than 200 Gap stores in the next two years as part of a restructuring. The news comes as GPS reported earnings that beat estimates but revenue that disappointed. 

Figure 1: The yield on the 10-year Treasury jumped Thursday after a better-than-expected showing from government GDP data. Strong economic growth can lead to higher interest rates as market participants feel less of a need for the perceived safety of U.S. government debt. Still rates remain low compared with the most recent peak above 3.2% late last year. Last year, strong economic data helped push yields higher, but yields quickly fell along with stocks as investors worried about the global economy. Data Source: Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Glance in the Rear View: One thing that can be good to keep in mind about the government’s GDP data is that it’s a lagging indicator, meaning that the numbers that get posted are essentially a look into the rear-view mirror for the economy. Of course, rear-view mirrors are there for a reason, though, and a quick glance can be useful. The stock market is about where it was in mid-October as Q4 was well under way. But conditions seem markedly different. Back then, stocks were on the decline amid fears that the Fed would raise interest rates too much, despite low inflation, and worries about the U.S.-China trade war. While there’s no trade deal yet, there appears to have been progress. But probably the most notable shift has been the Fed’s adoption of a dovish stance. 

The Fed and Yields: Sometimes, when interest rates at the longer end of the curve are low, it can be an ominous sign about the economy weakening. But at the moment it appears that another force is at work. One result of the Fed’s more dovish policy stance is that it is keeping its balance sheet large, which can help to keep longer-dated interest rates low even if the economy is doing relatively well. On Thursday, the yield on the benchmark 10-year Treasury rose, moving above the 2.7% mark, helped by the solid GDP report. Because bond yields move inversely to their prices, rising yields can indicate that investors are selling bonds because they don’t feel the need for as much of the security that low-risk U.S. debt can provide.

Change Afoot in EPS Expectations?: Amid the recovery in stocks from the swoon late last year, it seems that investors may be pricing in favorable geopolitical outcomes, which could end up helping to reverse a slide in earnings expectations. “Since prices frequently lead fundamentals, investors may now be anticipating the avoidance of a prolonged trade war with China and a hard Brexit,” investment research firm CFRA said in a note Wednesday, saying that “some believe the outcome of a second Brexit resolution vote could end up calling the whole thing off.” As of Wednesday, 2019 earnings-per-share (EPS) growth estimates showed expectations for a rise of just 2.8%, down from 6.5% year-to-date, according to CFRA. But a change could be on the horizon. “With the S&P 500’s multiple now slightly ahead of its long-term average, increased EPS growth expectations will likely be the catalyst needed to propel share prices further,” CFRA said.

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