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RoboStreet – May 17, 2018
Stocks Face Stiff Headwind from Rising Bond Yields
While stocks have made a nice comeback from a crucial technical test of the 200-day moving average, there are some clouds forming on the horizon I see as potential obstacles in the way of a rally above prior highs. A lot of attention is focused on the U.S.-China trade talks, the reworking of NAFTA, the summit with North Korea, tariffs on European imports and the U.S. pullout of the Iranian nuclear deal.
As far as geopolitics go, this is a full plate deserving of investor consideration as all of these situations are very fluid and could result in good news for the market or provoke real downside risk- depending on how they unfold. At the present, the market is content giving the benefit of the doubt to the notion that cooler heads, rational dialogue, and negotiations will prevail. We can see this in the persistently benign level of the volatility indicators. The level of worry by investors is not elevated, at least not now.
Beyond this mix of potential headline risk are three other factors I see as fundamental risks to the market’s near-term uptrend. They would be the strong dollar, spiking oil prices, and rising interest rates. This could be a trifecta of trouble if they all continue to trend upward in coordinated fashion. Granted a stronger economy warrants higher energy prices from rising demand, a rising dollar computes when considering the Fed is shrinking its balance sheet and rising interest rates make sense when the Fed is embarking on a tighter fiscal policy after a decade of financial stimulus.
And remember we’re not talking about day-trading here. I’m looking for 50-100% gains inside of the next 3 months, so my weekly updates are timely enough for you to act.
Crude this month has been touching levels last seen more than three years ago as global supplies tighten amid fears over the implications of the Iran nuclear accord breakup. As of Thursday, North Sea Brent traded up to $80.00/ bbl while WTI crude hit $71.50/bbl at a time when the summer driving season officially kicks off Memorial Day weekend two weeks from now. Average gasoline prices across the U.S. are fast approaching $3.00 per gallon, which for many Americans that commute long distances is a serious budget item to contend with.
The sharp move up in the dollar of over 5% has occurred in the middle of the second quarter and will surely show up as a forex headwind to profits for most multinational companies when they report Q2 earnings. Here too, companies have enjoyed Goldilocks conditions for so long that the market may react negatively if the dollar continues to climb. And from a technical standpoint, it looks very much like it will. The dollar index (DXY) currently trades at 93.44 with overhead resistance at 95.0. A move through that level opens the way for a further rally to 100.0 where that would prove to be very problematic for companies doing more than 50% of business overseas.
And while rising oil prices and the bullish move in the dollar are more apt to be more manipulated by new supplies hitting the market and central bank injections to stem further price increases, there is little the market or outside forces can do to stem the rise in bond yields if the market senses inflation and a hawkish Fed. This is where I see the current rally running to some summer seasonality where volatility will pick up as we approach the next FOMC meeting slated for June 13. There is currently a 95% probability the Fed will raise Fed Funds by a quarter point to 1.75%-2.00% according the CBOE FedWatch Tool site.
This would make for the second hike this year with Fed Chairman Jerome Powell having openly voiced his view that there could be four rate hikes in 2018. That would imply another hike in September and then again in December. The domestic economy is expanding at a 3.0%+ clip for GDP, inflation indicators are ticking higher, and Q2 corporate sales- and earnings growth- are looking to exceed that of the first quarter. The market, being a forward discounting mechanism, will start taking into account the longer-term effects of higher bond yields on businesses and consumers.
To that point, I think the market can transition to these eventualities, but not without some bouts of volatility along the way that will test the mettle of investors similar to what occurred during February and March. Essentially, I do not expect a smooth ride for the stock market during the summer months and investors should maintain a cautiously optimistic stance in how they manage their portfolios.
With this scenario, the financial sector stands to benefit as one of the go-to sectors for garnering potential profits. We are currently long JP Morgan (JPM) in the RoboInvestor Portfolio with a cost basis of $110.16. As of this week, the stock trades at $113 and- as per my Tradespoon Stock Forecast Toolbox- the six-month upside target for shares of JPM is around $129, or roughly 14%+ higher. When compared to other sectors, the risk/reward ratio for owning JP Morgan is excellent and should be considered as a stock to buy on any short-term weakness.
My ‘always learning’ Artificial Intelligence system ranks JP Morgan with a Model Grade “A” rating, placing it in the top 10thpercentile of accuracy relative to our total data universe. This is the kind of stock where rising interest rates and bond yields act as a tailwind. Banks borrow short and lend long, and JP Morgan is the largest bank in the U.S. run by one of America’s smartest banker CEOs Jamie Dimon.
The stock traded recently as high as $119.33 and should see that level again and push above $120 as capital flows continue to rotate into the mega banks against the backdrop of rising interest rates. It’s a recipe for expanding bank profits and the market, in my view, will reward shares of JP Morgan in the form of setting new all-time highs in months ahead. There is always a bull market somewhere, and currently it’s in the bank sector- specifically JP Morgan.
And remember we’re not talking about day-trading here. I’m looking for 50-100% gains inside of the next 3 months, so my weekly updates are timely enough for you to act.
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