If you have been listening to our weekend show, I’ve covered some topics weekly that suggested we were anticipating some seasonal performance issues ahead in August with the month typically being a month we’ve seen volatility in the past. Considering the US equity markets were at all-time highs in July, it wasn’t so far-fetched an idea. Then the divergences began with the Dow Jones Industrial Average being the only index that was still going up. That’s typically a warning that breadth (or participation) was waning and a correction was due. The dip came and went and despite the natural disasters and missile shot across Japan’s bow, the market surprised everybody and rallied strong driven by technology and other growth areas. The Dow warned, but the Nasdaq answered.
After reaching fresh highs in July, the Russel 2000, the Nasdaq Composite, and the Dow Jones Transports began to consolidate. Meanwhile, the Dow Jones Industrial Average continued to climb into August. Whenever large cap companies outperform against small cap or the energy-sensitive transport index, it’s typically a leading indicator that investors are shifting risk out of the market.
Some of the angst that led to the weakness in the market in August was related to the saber rattling between North Korea and Trump. Threats were made and it seemed the two were escalating matters publically. Nothing came from the tension their comments made, but it was enough to unsettle the market which had been pricing volatility at a very low level.
Trump: North Korea ‘will be met with fire and fury like the world has never seen before.’
Speaking of volatility, Doubline Capital’s Jeff Gundlach bought 5-month S&P puts due to a low price for volatility as represented by the VIX index. Part of an option’s valuation is time and volatility. This was another catalyst that put investors on edge as the announcement helped spike the VIX and drop the S&P 500 20 points on July 27th. The second announcement that helped rock the markets in August was the handling of Charlottesville and the resulting exits made by many on his business councils. This eventually led to the disbandment. This was really tragic as now those CEOs and executives have lost their ability to help change policy in Washington.
With this week’s North Korean missile strike, which flew almost 1,700 miles over Japan’s northern island of Hokkaido, investors had the ammunition to further de-risk and raise more cash to finish the month. Futures were pointing at a decline of 0.5% to 0.8% that morning. Investors have seen North Korean missile tests before and equities were able to rally throughout the rest of the day.
Behind all of these August machinations, I mentioned on my wrap-up report with John on the podcast that there was an underlying theme that would support whatever dip we get from seasonality or some of the other geopolitical headlines. That theme was moderate economic growth (LEIs still pointing towards expansion), a great earnings season, and a Fed that is likely to stay paused on rates until December (which is 50/50 at this time). The only other roadblock that was holding back bullish sentiment recently has been the anticipation of a political fight over the debt ceiling when Congress reconvenes. If anything, the natural disaster and the call to help Texas in its time of need due to Hurricane Harvey this week has helped to raise the probability Congress will raise the debt ceiling, no questions asked.
It is unclear for now what kind of economic impact Hurricane Harvey will have on GDP, but we know that spending will be released to help. GDP in the second quarter was revised higher this week at an annual rate of 3.0% versus the advance estimate of 2.6%. Consumer confidence was released on Friday with respondents mainly more optimistic about conditions ahead than where we are now. Overall that caused the index to rise 3.4 points over July. There is a high belief that finances will outpace inflation.
Finally, this week in economic data, the jobs report showed 156,000 jobs were added in August, below last month’s 209,000. Over the past five years, according to Moody’s, upward revisions have averaged around 40,000 to the first print. Taken with a grain of salt, most of the weakness was in leisure/hospitality which has averaged around 30,000 each month, was only a mere addition of 4,000 jobs in this report. September is also likely going to be a non-event as many will anticipate any weakness as temporary and related to Hurricane Harvey.
In other news, gold broke out this week above ,300 on the day of the North Korean missile test, August 29th. It has held above that breakout and closed Friday at ,329. I’ve mentioned on the show numerous times that 00 was a key technical level which now draws ,400 into play. If ,400 is broken you are looking at a cyclical bottom in gold, not just a long-term bottom. I believe this year’s consolidation in gold is over and the next wave higher looks to be here.
The breakout in gold follows the one we’ve already seen in copper earlier in July. It is clear to us that the reflation trade is alive and well again.
Commodities in general continue to show that Dr. Copper is on to something for the reflation trade. With the exception of a few agricultural areas, many commodity ETFs are beginning to improve their relative strength versus the rest of the S&P 500 as shown on this relative rotation graph (RRG).
And last, to sum up this week, there has been more discussion about bubbles and a comparison of bitcoin to the tulip mania of the 17th century based on bitcoin’s rocket performance this summer. If you don’t know what the tulip mania is (I learned about it on Wall Street: Money Never Sleeps) it can be easily googled, but what’s interesting is the 1) volatility of bitcoin this week following the North Korean missile strike, 2) the comparison to the tulip mania, and 3) the release of a new film, Tulip Fever, today bringing to life the work of the 1999 bestseller of the same name. Quite the coincidence!
