Over the last week, uncertainty about the tax bill, another missile launch from North Korea and continued volatility in Chinese markets have been overwhelmed by genuinely positive economic data in the United States. While we see current market conditions as being net-positive for stocks, it might also trigger an interest-rate-driven rotation, which could present some risks.
Besides some very bullish comments from the next Fed Chair, consumer confidence hit a new high on Tuesday, new home sales and prices reached multiyear highs on Monday and third-quarter GDP was revised higher to 3.3% on Wednesday.
Overall, the data seem to be pointing towards a healthy economy.
Growth tends to lead to inflation, which drives interest rates higher. This is good for some sectors, but hints of rising rates have been a bad thing for others. For example, as you can see in the next chart, technology stocks — as represented by the SPDR Technology ETF (NYSEARCA:XLK) — dropped suddenly as rates spiked a little higher on Wednesday.
The decline on Wednesday will likely complete a small bearish divergence, which points to additional losses in the short term.
SPDR Technology ETF (XLK): Chart source — TradingView
Technology stocks are sensitive to higher interest rates and underperformed the last time we saw a big change a year ago. Stocks in the financial sector (except payment companies) tend to do much better in an environment where rates are rising.
It is too early to suggest that rising financials and flat tech will be the theme through the end of the year, but this week is already looking a lot like last November.
This still leaves open the question we started with — will rates spike in the near term? If economic data continue to look good, we think the probability that rising inflation levels will push interest rates higher through the end of the year is very high. The news flow next week will likely either make or break the forecast for the rest of the year. Positive labor and manufacturing data are expected, and the tax bill in the Senate should be settled. While we have positive expectations for these events, any of them could also act as a spoiler.
Despite Wednesday’s market volatility, the underlying fundamentals still look good. The tax bill’s potential failure is a risk, but we think the odds are shifting further in favor of passage.
Assuming traders aren’t disappointed by the data next week, we expect interest rates to rise, which should create some interesting opportunities in financial stocks.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
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