Fed rate hike and FANG shakeup could snap stocks out of spring lull

12-06-2017

Fed rate hike and FANG shakeup could snap stocks out of spring lull

Stock market volatility could pick up in the week ahead, as traders await the Federal Reserve and watch to see whether the shakeout in tech and momentum stocks continues. The Fed begins its two-day meeting Tuesday and is expected to raise the range for the fed funds target rate by a quarter point Wednesday afternoon. Fed officials should also give a nod to the fact that inflation is weaker but that they remain confident about the economy. Fed Chair Janet Yellen is also expected to talk more about how the Fed could move ahead to pare back its massive $4.5 trillion balance sheet later this year. The stock market had a relatively quiet week until Friday — when big-cap tech and other high-flying momentum names plummeted, taking the Nasdaq down 1.8 percent. The Dow closed at a new high on the same day. The selective selling came as investors put fresh funds to work in financials and energy. Big-cap tech names were hard hit after leading the market higher for weeks. Goldman Sachs, in a report on valuations, said Facebook, Apple, Amazon.com, Microsoft and Alphabet [Google's parent] are equal to 13 percent of the S&P 500 but provided 40 percent of the gains so far this year. Goldman analysts questioned the group's valuations and said the volatility in those stocks had become so low that they were less volatile than safe-haven plays, such as utilities. Even with a 3.2 percent loss Friday, Facebook was still up 30 percent for the year. "What we'll have to see is whether that loss of momentum will bleed over into other sectors, and, to that respect, what the Fed says and how their body language is becomes even more important," said Julian Emanuel, equity and derivative strategist at UBS. "We will want to see reassurance that the economy is on track. "It's a change in sentiment that in the near-term, at a minimum, stops the momentum," he said. "We have to see if there's downside follow-through in the next week." There is also a slew of data, but two very important reports — CPI and retail sales — will be released just hours ahead of the Fed's 2 p.m. rate decision. Core consumer price index is expected to be up 0.2 percent, for a year-over-year advance of 1.9 percent, just below the Fed's 2 percent target. The PCE deflator, the Fed's preferred inflation measure, is running even lower, close to 1.5 percent. Retail sales are expected to rise just 0.1 percent. The concern has been that a batch of softer-than-expected data is signaling a sluggish economy in the second quarter. Economists forecast growth at about 3 percent, but their forecasts had been higher. Strategists say the Fed could say more about inflation based on the CPI data, but it's unlikely even a very weak report would deter the Fed from hiking interest rates. Emanuel said if the Fed sounds neutral or more hawkish that will be a positive for the stock market rotation that started in the past week with funds going into financials. The sector was up nearly 2 percent Friday, while tech sold off, and it gained 3.6 percent for the week. "We actually think it will be tough for them to be more dovish than what the market is pricing," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch. "If you look at the expected number of hikes over the next couple of years, it's pricing in a slow path. They're not pricing in a lot of concern about runaway growth or inflation any time soon." Cabana said the market is pricing in a full rate hike for June but only a 45 percent chance of a second hike by the end of the year.

Tech bounce?

Stocks finished the week mixed, with the S&P 500 off 0.3 percent to 2,431, and the Nasdaq off 1.5 percent at 6,207. The Dow was higher for the week, up 0.3 percent. Small caps were the standout, rising 1.2 percent for the week at 1,421, as investors rotated into small caps, as tech sold off. Emanuel said he had expected profit-taking in big-cap tech since the group was overvalued and investors are moving into the stocks that had been lagging. He said the 4 percent intraday move in the Nasdaq 100 Friday changes the tone of the low-volatility market. "When you have a move of this magnitude, the one thing we know is volatility is now heightened, and volatility can work in both directions. We will just have to see how deep the psychological change is with investors, having two days to think about it," said Emanuel. "It doesn't interrupt our long-term view … but too much of a good thing can be too much of a good thing," he said. "That's what the market is telling us." Strategists expect to see some bargain-hunting among the beaten-up names in tech. "We went parabolic. This is what happens when you go parabolic," said Peter Boockvar, chief market analyst with the Lindsey Group. "The real test is what happens after the bounce. You know there will be dip buyers. If we fail and have a lower high, from a technical perspective, that tells you it could be something deeper than this." Boockvar said the tech stocks are also sensitive to higher rates and growth, so they could be impacted by the Fed, especially if it is not optimistic about growth. The rotation into some stock sectors, like financials, began after the written testimony of former FBI Director James Comey was released Wednesday afternoon. Traders said there was relief that Comey did not allege that President Donald Trump was obstructing justice or that he was the target of the investigation into his campaign's ties to Russia. Some traders saw it as a sign that Congress may now be less distracted and can now look at pro-growth policies, such as tax reform. "I think that the market actually took this released testimony to indicate that there wasn't a clear smoking gun," said Cabana. "There wasn't much we didn't already know, so I think there was a little bit of relief after that largely because there wasn't another shoe to drop. While the testimony made for interesting theater, I don't think it really gave the market a tremendous amount of direction." Attorney General Jeff Sessions appears before the Senate Appropriations Subcommittee on Commerce, Justice and Science Tuesday. The hearing was scheduled to focus on the 2017 budget request for the Justice Department, but Sessions is expected to be asked about his role in Comey's firing. Cabana said yields could rise into the Fed meeting next week. There are auctions for 3-year and  10-year notes on Monday and the 30-year bond on Tuesday.