U.S equities mostly finished lower on Friday, ruining what could’ve been the first “perfect week” for the market since early 1998. That is, up every single day of the week with each notching a new record high. This also ended a five-day winning streak for stocks and represented only the third down day since the post-Brexit rebound began.
Equity futures weakened after the close on reports of a military coup attempt in Turkey, which is a NATO member. This adds to the geopolitical tension following the truck attack in Nice, France overnight.
In the end, the Dow Jones Industrial Average gained 0.1%, the S&P 500 Index lost 0.1%, the Nasdaq Composite lost 0.1% and the Russell 2000 lost 0.3%. Elsewhere: Treasury bonds weakened, the dollar was mostly higher, gold lost 0.4% and crude oil gained 0.6%.
Consumer discretionary stocks were under pressure with Chipotle Mexican Grill, Inc. (NYSE:CMG) down 3.1% on a Morgan Stanley downgrade. Citigroup Inc (NYSE:C) lost 0.3% despite an earnings beat as it fell short of the high bar set by JPMorgan Chase & Co(NYSE:JPM) on Thursday.
Wells Fargo & Co (NYSE:WFC) fell 2.5% after reporting in-line results on concerns about the health of the energy sector. Net interest margin missed expectations while a decline in the quality of energy and gas loans drove a $150 million credit reserve build.
Herbalife Ltd. (NYSE:HLF) gained 9.9% on the announcement of a settlement with the FTC after regulators determined the company is not a pyramid scheme.
The economic calendar was busy. Retail sales posted a better-than-expected 0.6% gain in June vs. the 0.1% expected. The ex-autos result was 0.7% vs. the 0.4% gain expected. Consumer price inflation is running hotter than expected, as shelter costs rise and the labor market tightens, further pressuring the Federal Reserve to raise interest rates this year despite futures market expectation of no action until late 2017 at the earliest.
Another Fed worry that is fading is the economic situation in China, with second-quarter GDP growing at a 6.7% annual rate, unchanged from Q1 and ahead of the 6.6% estimate. Industrial production and retail sales all beat estimates.
Looking ahead, the bulls will have a number of new catalysts to deal with when trading resumes on Monday morning. The attack in France and the ongoing coup attempt in Turkey add to the still evolving Brexit situation in the United Kingdom. Europe is a hot mess right now at a time when economic growth is uneven and debt and deflation remain acute problems.
We have Federal Reserve and Bank of Japan policy decisions at the end of the month. Stocks have been surging on hopes that former Fed Board Chair Ben Bernanke’s pilgrimage to Tokyo to talk up “helicopter money” stimulus with the Japanese will end that country’s long malaise. Unfortunately, there could be legal hurdles to the dreams of monetized fiscal spending that Bernanke envisions.
As for the Fed, after a super-strong June jobs report and a massive post-Brexit market rally, Federal Reserve Board Chair Janet Yellen and her cohorts are quickly running out of excuses to not raise interest rates. Stocks won’t like this.
The set-to-be-disappointing Q2 earnings season will heat up as well, with 140 S&P 500 companies set to report (only 7% have reported so far). According to FactSet, S&P 500 earnings are set to decline 5.5% from last year for the fifth consecutive quarterly decline. As earnings have stalled but prices keep rising, the S&P 500’s trailing 12-month price-to-earnings valuation ratio has swelled to its highest level since 2010 (19.4x) and is well above its five-year (15.8x) and 15-year (17.6x) averages.
And finally, keep an eye on the recent rebound in long-term interest rates. The U.S. 10-year yield has gained about 20 basis points (or 0.20%) over the last two weeks on higher inflation and economic growth expectations spurred by all the talk of Bernanke’s helicopter.
The ironic catch in all this is that if central bankers are in fact successful in revitalizing growth and inflation — led by Japan — it could badly destabilize the bond market where roughly a quarter of government bonds (and a growing share of the corporate bond market) is trading with negative interest rates — roughly $13 trillion worth in total.
According to Goldman Sachs, a 1% rise in long-term interest rates would generate a mark-to-market loss of $2.4 trillion due to the impact of duration — which is like leverage. When bonds have a longer time to maturity, and a lower interest rate, the price sensitive to interest rate changes is multiplied.
Bond investors should be feeling very, very nervous.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
