Losses Everywhere

The major domestic equity benchmarks ended last week lower, with the large-cap indexes holding up substantially better than the tech-heavy Nasdaq and the smaller-cap benchmarks. Trading volumes were elevated, especially later in the week, and the VIX jumped to its highest level since April. Within the S&P 500, energy shares were among the best performers, boosted by a rise in oil prices, as traders braced for the implementation of new sanctions on Iran in early November. Financials shares also outperformed, helped by a surge in longer-term interest rates, which bodes well for bank lending margins. Utilities stocks, which typically perform poorly as rates rise, were among the week’s best gainers as they seemed to benefit from a general migration to more defensive stocks. The strong relative performance of the three sectors helped slower-growing value shares easily outperform higher-valuation growth stocks for the week.

Consumer discretionary shares lagged due to weakness in Amazon, which now makes up roughly one-third of the sector, following the transfer of fellow internet giants Netflix and Facebook to the new communication services sector. Amazon shares fell in the wake of news that it had raised its internal minimum hourly wage to $15 and a Bloomberg report — disputed by Amazon — that the company’s servers had been hacked by the Chinese military through the use of tiny chips implanted in motherboards. News of the possible hack also seemed to derail a rally in the shares of Apple, which also denied the alleged penetration of its servers.

Markets got off to a solid start for the week following the announcement that Canada had joined the U.S. and Mexico in a revised North American Free Trade Agreement, now to be known as the United States-Mexico-Canada Agreement, or USMCA. Traders noted that the sharp gains Monday morning probably reflected a thirst for any signs of trade progress, but the larger issue of trade with China still loomed in the background and seemed to take the air out of the rally Monday afternoon. Tensions with China appeared to escalate late in the week after Vice President Mike Pence gave a speech harshly criticizing Chinese trade policy and accusing China of attempting to interfere in U.S. elections.

The week’s most notable development for both the stock and bond markets was the sharp increase in longer-term interest rates. The yield on the benchmark 10-year U.S. Treasury note jumped from 3.06 percent at the end of trading the previous week to 3.25 percent in intraday trading Friday, its highest level since the summer of 2011. The biggest move occurred Wednesday and appeared to be sparked by an interview with Federal Reserve Chairman Jerome Powell, in which he described the economy as “firing on all cylinders.” U.S. economic data released Wednesday seemed to confirm Powell’s comments. In particular, the Institute for Supply Management’s gauge of service sector activity jumped to its highest level since the Institute began collecting data a decade ago. The ADP monthly report on private sector payroll gains also came in higher than expected.

The government’s official payrolls report, released Friday morning, was mixed but failed to reverse the increase in bond yields. The Labor Department reported that employers added 134,000 jobs in September, the smallest gain in a year. However, the unemployment rate fell to 3.7 percent, its lowest level in nearly five decades. However, there are at least two caveats to the headline number in the details of the report. First, Hurricane Florence appeared to be partly responsible for the drop in payroll gains, particularly due to a decline in employment in the leisure and hospitality industries. Second, the previous two months’ gains were revised substantially higher. Nevertheless, the report seems to indicate that the gradual cyclical moderation in the labor market that began in 2015 has resumed.

Overseas, European stocks followed U.S. equities lower amid a rise in global bond yields and continued worries about the Italian government’s spending plans. For the week, both the pan European STOXX Europe 600 Index and the FTSE MIB Index dropped 1.8 percent. In Asia, Japanese stocks were down along with most of the world. Mainland Chinese stock markets were spared by being closed for the week-long National Day holiday, but trade tensions loomed in the background as Beijing said it would cut tariffs on a wide range of products to soften the impact of U.S. tariffs.

Other news and notes follow.

• Fed Chairman Jerome Powell said tax cuts and spending increases could hobble the government if it has to respond to a downturn.
• However, “There’s no reason to think this cycle can’t continue for quite some time, effectively indefinitely,” Powell said later last week.
• Federal spending has ballooned in recent years, but comparatively less money has been spent on public goods — things like national defense, basic scientific research, and roads. Many think that more spending on public goods would be a good thing. The problem is in deciding which public goods are “good.”
• The U.S. and Canada reach a new trade agreement.
• Two-thirds of business economists in the U.S. expect a recession to begin by the end of 2020.
• Third quarter earnings season is quickly approaching. Ninety-eight companies have commented about upcoming results and 76 percent of these preannouncements have been negative.  Historically, about 71 percent of preannouncements are negative.
• The S&P 500 has never dropped in the year after midterm elections since the 1946 cycle — and has climbed 15 percent on average — regardless of which political party won or lost control of Congress.
• About 44,000 Verizon employees, or more than a quarter of the company’s workforce, were offered voluntary severance packages last month, as the carrier sought to cut $10 billion in costs and upgrade to a faster, 5G network.
• U.S. Treasury ETF total returns since the all-time 10/30 year yield lows in July 2016: 1-3yr (SHY): -0.2%; 3-7yr (IEI): -3.8%; 7-10yr (IEF): -8.1%; 10-20yr (TLH): -11.0%; 20+yr (TLT): -15.5%; and 25+yr STRIPS (ZROZ): -22.2%.
• Amazon increased the minimum wage for all its U.S. workers to $15 per hour.
• The ISM manufacturing report continues to show robust factory activity across the U.S. The headline ISM index remains near multi-year highs.
• Nearly $3 billion flowed out of government-bond funds during the week ended September 26, the largest weekly outflow since November 2016, according to a Bank of America Merrill Lynch analysis of EPFR Global data.
• Netflix shares have surged 99 percent this year and are the third-best performers in the S&P 500, behind those of chip company Advanced Micro Devices and medical-device company Abiomed.
• 95 percent of Americans own a cellphone, while 77 percent own a smartphone. 89 percent of Americans use the internet; 69 percent use social media.
• After rising 7.7 percent in the third quarter, the S&P 500 has now shown positive gains in 21 out of the past 23 quarters going back to the start of 2013. Since Q2 2009, the S&P is up 32 out of 38 quarters.
• Ten years ago last week, in the depths of the financial crisis, President Bush signed into law a $700 billion plan to rescue the U.S. financial system.
• Eighteen years ago, GE was viewed as a company that could do no wrong. It was the largest company in the world. Its management was viewed as nearly omnipotent and every organization attempted to emulate it. It was the most widely followed and was the most recommended stock in history. Its AAA rating was sacrosanct. Today it is a shadow of itself, down about 82 percent in value from its apex, viewed by many today, at best, as a “speculative buy.”
• Consumer confidence is surging. Consumer spending is solid. The holiday shopping season is expected to be strong. But mall vacancy rates rose to 9.1% in the third quarter, their highest level in seven years.

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