The key political themes from last week: Brexit and US-China trade wars are set to take a back seat on Monday as the market focuses on some key US earning releases and gears up for a week of crucial economic data and central bank statements.
Earnings bonanza to drive S&P 500
Earnings releases including Bank of America (NYSE:BAC) and Blackrock (NYSE:BLK) will give some more colour to the Q2 earnings outlook for the finance sector, after JP Morgan smashed earnings expectations last week.
Netflix (NASDAQ:NFLX) results, scheduled for release after the market close today, will also be watched closely. This is one of the first new wave of tech titans to release Q2 earnings, and since tech has been the key driver of the S&P 500’s recent rally (the S&P tech sector reached its highest ever level on Friday, as you can see in chart 1 below), a strong set of earnings for Netflix could help lift the sector, and the entire S&P 500, in the coming days.
S&P 500 Tech Sector
The S&P 500 reached its highest level since early February at the end of last week, and early indications on the US futures market suggest that the S&P 500 is set to open higher today.
Its performance this week is likely to be dominated by how well US financials and tech stocks performed in Q2. It is worth noting that Netflix may be a key driver of the S&P 500 in the short term. The stock reached a record high at the end of June, but it fell sharply on Friday, after UBS (NYSE:UBS) downgraded it to a “hold” from a “buy”.
Taking into account Netflix’s drop on Friday, sentiment towards the stock is strong, it is up some 170% in the last year, and so if it can beat estimates of Earnings per Share of $0.79, then we could see the tech sector continue to fuel the rally in US indices.
Dollar doldrums
The dollar is on the back-foot today, and is down versus all of its G10 counterparts bar the yen, which continues to slide. Safe havens are being dumped this week as geopolitical and economic tensions fade to the background.
We expect the pound to be in the spotlight this week as we wait for key UK economic data ahead of the next BoE meeting next month. While the market is fairly confident that the BoE will hike rates next month (and woe betide any central banker who doesn’t give the market what it wants) the real driver of sterling will be expectations for rates further out along the curve.
A strong set of labour market, wage and retail sales data could drive expectations of a second rate hike before year-end, which may give GBP/USD the boost it needs after it dipped below key momentum indicators last week, including the 50-day sma. A strong set of data could trigger a move in GBP/USD back to 1.3323 – the 50-day sma and a key first line of resistance.
The most important chart for financial analysts right now…
Overall, the moves across global asset markets have been confusing in recent weeks: trade wars intensify yet global stock markets rally and gold falls?
We believe that what is really driving financial markets is actually taking place in the bond market. The important US yield curve has continued to invert (where longer-dated yields are falling at a faster pace than shorter-dated yields), which is a sign that the market believes that the Fed will cut short its rate-hiking cycle, potentially as early as next year.
Lower interest rates help to boost stock markets, as investors anticipate that the cost of capital will fall, which can trigger a flurry of buying in global stock markets, as we have seen. However, for gold, an inverted yield curve is negative, since the yellow metal is an inflation hedge, the yield curve suggests that in future inflation won’t be a problem so investors have less reason to buy gold, or gold-indexed funds.
An inverted yield curve also indicates economic slowdown and even recession, however, at this stage, when the US economy is doing very well, the market can ignore the warning signs from the inverted yield curve and concentrate on the good news story: potentially lower interest rates in future.
Will history repeat itself?
Just how inverted is the yield curve? As you can see in chart 2, which shows 10-Year US Treasury yields – 2-Year US Treasury yields, the yield curve has been inverting (when 10-year yields fall at a faster pace than 2-year yields) since 2013.
What has really changed is how dramatic the inversion is, it is now less than 25 basis points, which is the lowest level since 2007. If it continues in this fashion then the yield curve could turn negative, when 10-year yields are lower than 2-year yields, which is a key indicator that a recession is coming. While the yield curve and the S&P 500 do not have a long term decent correlation, between 2007 and 2008 the S&P 500 dropped by a whopping 52% as the financial crisis took hold, prior to 2007, the yield curve turned negative during the dotcom bubble. This time, the yield curve may be warning us that the next crisis is on the horizon.
For now that is not on investors’ minds, instead the prospect of lower yields may drive markets higher, but for how long, that is the question.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient.
Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.