Yellen Testimony, Strong GDP Reading In Focus As Market Sits At Record Highs

A missile launch couldn’t punch a hole in Tuesday’s tax reform- and Fed-fueled rally. Stock futures moved solidly higher ahead of the opening bell Wednesday as the market appeared ready to build on its gains.

Coming up today: Fed Chair Janet Yellen’s testimony to Congress on the state of the economy and the economic outlook at 10 a.m. ET, along with the Fed’s Beige Book release at 2 p.m. ET. This morning, the government released its second estimate for Q3 gross domestic product (GDP), and it came in at 3.3%, above the 3.2% that Wall Street analysts had forecast. And the full Senate is expected to vote on a Republican tax plan later this week.

It looks like there’s less fear of North Korea and more optimism about events in Washington, D.C., at least judging from the action on Wall Street yesterday. First, stocks sold off on the North Korea missile launch, then they came roaring back amid positive sentiment surrounding Fed nominee Jerome Powell’s testimony and the Senate Budget Committee’s approval of tax legislation. The tax vote and Powell testimony both got investors excited, helping carry major indices to new all-time highs and writing another chapter in the market’s incredible rally.

The full Senate still has to take action on taxes, but there was some concern that the Budget Committee might reject the bill. Tuesday’s vote removed one source of potential stress on the market. Without taking sides on a political matter, it’s fair to say investors generally like to see Washington functioning, and the vote yesterday might be a sign of that. What the legislation ultimately looks like and how it might affect the markets remains to be seen, but the general mood on the Street is optimism about possible corporate tax cuts.

Financial stocks, which had already drawn support from what many viewed as constructive testimony by Fed Chair-nominee Jerome Powell in his confirmation hearing, took on even more vigor after the Budget Committee vote. Powell said all the things that might be expected of a Fed nominee on rates and the economy, so that wasn’t too surprising. But investors appeared to like what he said about regulation, particularly his comment about Wall Street regulations being “tough enough.” Banks have lobbied to have the reigns loosened, so Powell’s remarks likely were what bank leaders wanted to hear.

Financials easily led all sectors with 2.6% gains Tuesday. No other sector came really close. Still, the rally was pretty broad, with telecom also rising more than 2% and several other sectors posting 1% or better gains.

Consumer discretionary might have gotten some help from a National Retail Federation (NRF) news release showing that 174 million Americans went shopping over the Thanksgiving weekend, which included both Black Friday and Cyber Monday. That was about 10 million above expectations. The NRF cited good weather, lower unemployment, and strong consumer confidence as factors, and added that online and mobile phone shopping both looked solid.

Even while stocks flew higher, crude oil edged down early Wednesday as investors awaited Thursday’s OPEC gathering. There’s a lot of scuttlebutt about how this might turn out, with some analysts predicting Russia might not be enthusiastic about extending production cuts beyond the current March expiration date. Some OPEC members could be getting worried about the impact of rising crude prices on U.S. production, which recently climbed to all-time weekly highs as prices probed the $60 a barrel mark. The weekly U.S. crude inventory report comes out later today and could provide more hints as to whether U.S. producers kept the taps running full steam ahead last week.

In the earnings arena, Tiffany & Co TIF reported results that beat analysts’ estimates, but the stock fell in pre-market trading. There was a surprise increase in same-store sales, which is good, but the company said strength in the U.S. and parts of Asia were offset by weakness in Europe and Japan.

As U.S. stocks keep posting new highs, some voices raised questions about this long rally. The latest was Vitor Constancio, vice president of the European Central Bank (ECB), who told CNBC this morning that U.S. markets look “overstretched.” Last week, Fed meeting minutes expressed concerns about “elevated asset valuations.” Constancio’s remarks Wednesday were in the same vein, as he warned that the cyclically-adjusted price to earnings (P/E) ratio is “well above” historical averages.

Investors should keep these warnings in mind, but remember, too, that this is a rally people seem to love to hate. Fundamentals still look mostly positive. Earnings were excellent, the U.S. economy is humming along, and interest rates and inflation both remain historically low. The government’s second estimate of Q3 GDP this morning once again showed impressive growth. None of this means stocks have to keep rising, but it does stand in contrast to some of the pessimism expressed by the non-believers.

FIGURE 1: WILL YOU FOLLOW? Ten-year Treasury yields are down over the last month and remain at relatively low levels. The financial sector (purple line) had been tracking lower along with yields, but got a big shot in the arm Tuesday. The question is whether bond yields might follow financials higher if the rally in bank stocks continues. Financial stocks often climb when investors expect higher rates. Data sources: Standard & Poor’s, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Inflation Puzzler’s Next Chapter

Last month’s meeting minutes indicated that Fed members remain puzzled by persistent low inflation readings. The inflation meter the Fed is said to watch most closely — personal consumption expenditure prices (PCE) — comes out tomorrow morning right at the open, and could provide further clues into the price picture as of October. Anyone looking for an inflation bounce, however, might be disappointed, assuming analysts’ expectations are in the ballpark. At this point, Wall Street analysts expect just a 0.1% rise in PCE prices, according to Briefing.com. That’s down from a 0.4% rise in September, which might have reflected some hurricane impact. PCE prices rose 1.6% year-over-year in September, below the Fed’s 2% goal, and core PCE prices rose just 1.3%.

Confidence Hits 17-Year High

Tomorrow’s PCE prices report comes after another strong consumer confidence reading. The headline figure rose to 129.5 in November, above Wall Street’s expectations and the highest reading in 17 years. The improving job picture might be helping shape consumer expectations, though, somewhat interestingly, the report showed consumers slightly less optimistic about short-term income prospects. Still, rising consumer confidence often translates into stronger consumer spending. With the holidays coming up, this is arguably good timing from a market perspective.

Bond yields — which can be responsive to consumer confidence data because sometimes more spending leads to inflation — bumped up slightly after the data but then relaxed again. All told, it seems a bit surprising that with all the positive sentiment Tuesday in stocks, bond prices also rose, sending 10-year yields down to 2.32% by late in the day. Perhaps that reflects a little concern over North Korea.

Capitol Matters

As we noted earlier this week, it’s important for investors not to get too charged up about the daily grind in Washington, D.C. However, one thing to watch is the Dec. 8 deadline for Congress to keep the government open, and developments on Tuesday could be taken as either positive or negative as far as the budget picture. On the one hand, Democratic leaders canceled a scheduled budget meeting with the president. On the other, the Budget Committee moved the tax bill to the full Senate, maybe a sign that the clockwork might be starting to tick in Congress. The VIX index, which tracks volatility, climbed back above 10 on Tuesday, but remains historically low. Keep an eye on VIX over the coming days because if investors start to sniff a government shutdown, that’s one place in the market where those fears might show up.