Facebook, Netflix, & The Russell 2000 All Hit Record Highs
Walgreens Could Help Struggling Dow
The trend of small caps outperforming large caps continued again as investors worry about the rising dollar and the trade skirmishes. I think that if a trade deal ends up being made with China, the Dow can rally at least 500 points as it has been the most hurt by these tariffs. The Dow was down 0.17%. The good news is GE was replaced by Walgreens Boot Alliance. That gives the Dow less exposure to the industrial sector which has been hurt by the tariffs. Since the Dow is priced weighted, Walgreens will be getting a much higher weighting in the Dow than GE. GE was the smallest stock in the Dow as it is at $12.88. Walgreens stock is at $68 which means the other stocks in the Dow will lose some of their impact.
Facebook Drives Up The Nasdaq
The S&P 500 was up 17 basis points which puts it in the middle of its very tight 2 week trading range. It looks like the S&P 500 has fallen more than it has in the past few days because the market has opened down big and then recovered a few times. The tech sector was up 0.33% which explains why the Nasdaq was up 0.72%. Netflix and Facebook both hit record highs. Facebook has had a huge turnaround ever since its data scandal earlier this year.
The big news from Facebook was the release of Instagram TV which is long form vertical videos to take on YouTube. I think the app should be built in to Instagram just like stories is built in. Alphabet made this mistake by separating Google Plus from YouTube initially. Now the social service is built in to YouTube.
That’s not to say the new app will definitely be a dud. Instagram TV should be more user friendly than Google Plus. Long form video is a huge opportunity for Instagram as the short form video it currently offers leaves a lot of time spent on the table. The other news was that Instagram passed 1 billion monthly active users as you can see from the chart below. Many social media users have migrated away from Facebook towards Instagram. For younger users, they simply have never created a Facebook and only use Snapchat and Instagram.
The Financials Are Still Weak
Facebook and Netflix hitting record highs is great news for the market as they have proven to be solid leaders for the past few years. The S&P 500 would make new highs if only the financials did better. The financials and the materials were the worst sectors as they were down 0.31% and 0.39% respectively. The financials are down 9.95% from their record high in January. They are being hurt by the flattening yield curve, the expectation that rate hikes are almost over, and weak loan growth. Also, the regional banks fully priced in the Dodd Frank reform bill before it passed, meaning they no longer have a positive catalyst to drive them higher. The KBW regional bank index is down 7.33% from the January 26th peak.
The good news is leading is showing signs of improving along with the economy. As you can see from the chart below, instead of going negative, year over year C&I lending growth bottomed at 0.5% in November 2017 and has since moved up to 3.3% as of May 2018. The improvement is definitely related to the easier comparisons being lapped. November 2016 year over year growth was 7.9% and May 2017 growth was only 2%. However, during recessions weak comparisons don’t help results. The past 3 recessions had C&I lending growth go negative by the end of them. The sharp decline in growth in 2017 makes it look like there would have been a recession if not for the tax cuts.
(Click on image to enlarge)
Another Winning Day For The Small Caps
The Russell 2000 hit another record high as it was up 0.8%. The small cap index is now up 11.17% year to date. The current 14 day RSI is 76.42 which means it is highly overbought. The Russell 2000 is more volatile than the S&P 500 which means it tends to get more overbought and more oversold than the S&P 500 even when there isn’t major news driving it. That’s not to say the dollar rally and the tariffs aren’t major events; it’s just a general point. The 14 day RSI peaked at 73.27 in January showing that the small caps are even more overbought than then cycle peak in optimism. This is the highest peak since October 2017 when it hit 85.40. The peak in January led to a much sharper decline than the one in October, showing that a higher RSI doesn’t mean a sharper drop in the index is coming. I’m expecting a small correction like we saw last fall instead of the sharp one in the winter.
Oil, Dollar, & Treasuries
Oil was up 1.8% to $66.22 as the market anticipates the OPEC meeting. The current situation is Saudi Arabia and Russia want to loosen supply controls while other countries such as Iran are against this because they want prices to stay high. There was a 400,000 barrel storage tank crash which caused Libyan supplies to fall and prices to rise. Finally, U.S. crude inventories fell by 5.9 million barrels according to the U.S. Energy Information Administration. Gasoline stockpiles rose by 3.3 million barrels and distillate fuel increased by 2.7 million barrels.
The dollar increased by 0.12% to $95.12 as it maintains its uptrend which hurts large cap stocks.
There was a sharp increase in yields as investors decided American growth prospects were rosier than they thought. The 10 year yield increased by 4.22 basis points to 2.94%. The 2 year yield only rose by 2.07 basis points to 2.57% which means the curve steepened sharply. The latest difference between them is 37.3 basis points. I see the 10 year yield as range bound between its recent high of 3.11% and its recent low of 2.78% for the rest of the year. I think the 2 year yield will increase along with the Fed funds rate for the rest of the year, getting close to 3% by the end of the year which will invert the curve.
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