Stocks End The Week On A Down Note

Technically the 0.85% selloff in the S&P 500 on Friday was bad news. It means the S&P 500 may have just made another lower high. There is going to be pressure to the downside as the S&P 500 tries to hold its previous low. The range is tightening to the downside. The market was brought down by Apple as I expected because of fears of iPhone sales. Apple stock was down 4.1% and is now negative for the year. With such negative news on its main product, to me it seemed like a clear sell on Thursday. I still wouldn’t buy it after this decline. The earnings report will either quell the fears of investors or cause the stock careening lower.

3 New iPhones Rumored To Be Released This Fall

Even though a new smartphone won’t be released until the fall, this quarter will give us an idea of how Apple will situate its new devices which will be launched this fall. The latest rumor is the firm is working on three devices: iPhone X SE, iPhone X2, and an iPhone X2 Plus. The SE could cost $550 and have an LCD screen which is 6.1 inches. This would show Apple is putting more effort into the mid-range products. The X2 and X2 Plus would have OLED screens and cost $899 and $999 respectively. The X2 Plus would have a screen that’s 6.5 inches, continuing the trend of screens getting larger. I’m expecting Apple to miss iPhone sales estimates. The bigger the miss, the more likely the mid-priced phone will have high end specs. The services sales will give us an idea of how the company will survive in a world with diminished smartphone sales.

Consumer Staples Hit A 52-Week Low

Consumer staples were down 1.68% on Friday which caused the sector to hit a 52 week low. Phillip Morris stock fell 1.6% after it had fallen 15.58% on Thursday. The stock is down 18.4% in the past 3 days. The dividend is now 5.08% which is about 2% higher than the 10 year bond yield which I’ll review later. The rising yields have hurt this sector. As the chart below shows, the ratio between the consumer discretionary and consumer staples sector is at a new all-time high. Since the consumer discretionary sector was down 1.02%, the record expanded on Friday.

(Click on image to enlarge)

The main reason the consumer discretionary sector has done well is because of Netflix and Amazon stock. Amazon makes most of its profits from Amazon Web Services which distorts the sector because that’s tech not consumer discretionary. Clearly the sector has never had a mega cap firm with a cloud division. This record also reflects how poorly consumer staples have done. There are a few negatives catalysts which are combining for an onslaught on the sector. First, the bull market of 2017 was a ‘risk on’ moment, so the conservative consumer staples underperformed. Even though there was a ‘risk off’ moment this year, because there were fears of rising rates and inflation, the consumer staples weren’t a safe haven.

The rising rates mean the dividends yields these firms have aren’t as big of an advantage as in the recent past. The 4.52% yield General Mills has exists because of the huge selloff in the long bond since the summer of 2016. Higher inflation means lower margins for these staples firms. Phillip Morris actually beat its revenue estimates. The investors focused on the weak sales from the heat not burn category because the sector is hated. Any reason to sell will be taken even if the firm reports a good quarter. I like this sector because I’m not sold on the reflation trade and I think slowing growth will cause investors to rotate out of the high growth names a bit.

Big Sell-off In The 10 Year Bond

As I mentioned, the consumer staples stocks declined because the long bond sold off. The 30 year yield increased 4.68 basis points to 3.1451%. It is still off its high for the year which was 3.22% in February. Friday was historic for the 10 year yield as it hit 2.96% which was an increase of 5 basis points. This is the highest point since December 2013 when it hit 3%. With the selloff gaining steam recently, it seems like it will easily break 3%. The 2 year yield only went up 3 basis points to 2.46% which means the yield curve flattened. As you can see in the bottom right of the chart below, the difference between the 10 and 2 year yield is 50 basis points. There has been an 8 basis point steepening in the past few days. As I had mentioned previously, the stability of the long bond was causing the curve to flatten. This recent reversal has ended that relentless flattening.

(Click on image to enlarge)

I find this action perplexing because we saw stocks selloff and bonds selloff while earnings have been great and the economic data has been missing estimates. I would expect stocks to rally and the long bond to rally on such news. In terms of the curve, this is clearly a countertrend rally like the numerous other examples. That was expected. The increase in the 10 year yield must be related to the expectation of heightened inflation. It’s debatable if stocks sold off as a result of the selloff in bonds. On the one hand, stocks weren’t down much. On the other hand, the market may have deserved to be up because of the great earnings, so down slightly is a bigger deal than lets on.

Conclusion

The long bond yields are following the inflation estimates higher. The 10 year breakeven inflation is at 2.17% which is the highest since 2014. This increase in inflation expectations is likely a combination of the expectation that wages will increase because of the tightening labor market and the rising commodities prices. I’m not sold on this movement because of the slowing economic growth. Clearly, I’ve been wrong in the past few days as I like consumer staples, equities in general, and the long bond and I don’t like energy. I have had good individual calls as I have liked Twitter and disliked Apple recently.