Stocks closed mixed on Friday as the recent rally, based on trade talk optimism, seemed to be running out of steam.
There are a few obvious reasons for equity markets to pause.
1. Stocks don’t go up in a straight line. While there will always be momentum chasers, even at market tops, fundamental investors find it increasingly difficult to buy stocks as prices rise. Just as you and I do when we shop retail, we look and admire, and then wait for a sale to buy.
2. 10-year Treasury rates have climbed from 1.45% around Labor Day to almost 1.95% today. Bonds compete with stocks for investor interest. The higher bond rates go, the more attractive bonds become versus stocks. When rates go up, bond prices fall. For two months bond prices have been falling as stock prices have been going up. While rising bond yields are a signal of a strengthening economy, the divergence in price action between the two large asset classes simply cannot go on indefinitely.
3. Earnings season is winding down. It has been pretty much as predicted. Earnings continue their flat pattern shown all throughout 2019. Flat earnings are no lift for stock prices.
4. Investors are tired of trade “happy talk.” Verbal agreements and friendly tweets do not constitute an agreement. While I am sure trade negotiators have agreed on several key points, they still are not in agreement on a total package. Most importantly, there seems to be significant disagreement as to whether there will be some rollback of tariffs to accompany any Phase I agreement. While there is little doubt that the Trump administration will try to make any Phase I agreement sound like a meaningful accomplishment, it probably will only be a small step in the right direction. Mr. Trump feels a small step doesn’t warrant a rollback of tariffs. The Chinese feel any step forward requires Trump to take a step back on tariffs. One side has to give and, so far, neither has relented.
5. Regarding trade, December 15 isn’t that far away. While markets still expect Mr. Trump to defer implementing a significant new round of tariffs, without an agreement market nervousness will rise as December 15 gets closer.
6. Besides trade, our Congress needs to pass legislation to keep the government funded beyond November 21, just 10 days away. Impeachment proceedings increase the acrimony between the White House and Congress. President Trump, once again, is waiving the flag for more Wall funding. A government shutdown is the alternative. Neither side wants to play that episode again, but there isn’t a compromise that satisfies both so far.
In short, pending deadlines and the lack of additional tailwinds suggest it might be time for stocks to take a breather. A breather in my mind is a pullback of a few percentage points, not a major correction. That assumes that the government gets funded near November 21 and, somehow, the President finds a way to defer the next round of tariffs. Implementing a major round of tariffs 10 days before Christmas is clearly a tough political step.
The next two weeks will otherwise be quiet except for earnings for the leading retailers. Economic news will also be scarce. That means political headlines (and I don’t mean the endless impeachment inquiry) will dictate the action in markets. The stock market is likely to take its cues from the bond market. Any further rapid change in rates will guide stock prices over the very near term. There is still likely to be a Santa Claus rally, but we have to see solutions to tariff and government funding issues first.
Today, Leonardo DiCaprio is 45. Demi Moore turns 57.
James M. Meyer, CFA 610-260-2220