US inflation, month-end “window-dressing’’ to set direction

Date: February 26, 2018

Last week’s report advised investors to keep an eye on movements in the US Treasury bond market because if the 10-year yield was to come close to or cross 3 per cent, Wall Street stocks could encounter heightened volatility as they did earlier this month. As it turned out, the 10-year Treasury rose 2 basis points on Tuesday to 2.89% and added a further 5 points on Wednesday to a 4-year high of 2.94% after release of the minutes of the January US Federal Open Markets Committee (FOMC) meeting, which suggested the Federal Reserve might raise interest rates four times this year instead of the three times the market is expecting.

In the accompanying policy statement, the Fed said it “expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate.”

On Wednesday, US investment bank Goldman Sachs noted the use of the word “further’’ and said it thinks there is a more than 95% chance that rates will be raised at the 20-21 March FOMC meeting, versus the 85% that the federal funds futures market is currently pricing in.

Also adding to interest rate and inflation concerns mid-week was Dallas Fed chairman Robert Kaplan, who on Wed warned that the US central bank risked falling behind the curve in raising rates.

With Wall St coming under pressure on Tue and Wed because of the rise in bond yields, the Straits Times Index underwent a volatile week. However, a jump in the Dow futures on Friday – and possibly early month-ending window-dressing – saw the index rise 44.76 points, bringing its gain for the week to 90 points or 2.6%. That jump in the Dow futures did indeed precede a Wall St rally on Friday that came when the 10-year yield retreated to 2.87%.

Turnover improved steadily, from S$1.1 billion on Monday (probably because many players were still away for the Lunar New Year break or suffering from a post-holiday hangover) to S$1.3b on Tuesday, S$1.6b on Wednesday, S$1.7b on Thursday and S$1.4b on Friday.

The rise in volume could also have been traders, funds and other players positioning themselves for the end of the month, which comes on Wed. As pointed out before in this report, the STI often undergoes large rises on the last day of the month. Although this usually happens at the end of each quarter, it does sometimes occur on other months.

As always, it was the banks which exerted the greatest influence on the STI – all three rose 2% on Friday. Also, in this category would be property stocks, which sprang into play after announcement of a higher buyer’s stamp duty in the Government’s Budget on Monday.

City Developments in particular, underwent large swings – on Wed for example, it jumped S$0.28 but on Thurs it plunged S$0.19 to S$12.60. The stock is well-known to be a favorite among proprietary desk traders, as are most of the penny stocks that regularly populate the actives list, eg Rowsley, Magnus Energy, Jiutian Chemical and Addvalue Tech.

In the conglomerate offshore and marine sector, shares of SembCorp Marine collapsed S$0.30 or 11.4% on Thursday after the firm posted a disappointing set of 4Q results – a net loss of S$33.8m versus a net profit of S$34.3m for 4Q 2016. On Friday it lost a further S$0.10 at S$2.23, bringing its 2-day fall to S$0.40 or 15.2%.

Returning to US inflation and interest rates, Schroders in its February Talking Point said inflation surprised to the upside in January with the headline consumer price index (CPI) rising 0.5% month-on-month compared with expectations of a 0.3% gain.

“The core rate (CPI excluding food and energy) rose by a more modest 0.3% month-on-month, but this was also ahead of expectations of 0.2%. These changes left the annual rate of CPI inflation stable at 2.1% year-on-year, but the core ticked up from 1.7% to 1.8%.’’

“The lags from the economic cycle to inflation are quite long and consequently the recovery in growth over the past year is likely to continue to fuel the cyclical component of inflation in 2018. In the absence of a significant slowdown in growth or weakness in the less cyclical parts of the index, core inflation looks set to accelerate further’’.

In other words, notwithstanding Friday’s session, investors should still bear in mind that volatility will remain high as US inflation and interest rate concerns persist.

Last but not least, a Straits Times reader wrote in with an interesting letter that was published on 14 Feb. In it, he noted “eerie resemblances’’ between the economic scenario in the decade leading up to the 1929 crash and years 2008-2018. He noted that it is not only weak economic fundamentals that can precede a market crash but also low money growth and a concentration of wealth.

“In 1921 a huge tax cut favouring the rich occurred, and unemployment rose sharply. In 1922 there was a sharp fall in interest rates, and a sharp rise in the stock market. In 1923, a very sharp decline in unemployment occurred, and the stock market continued to rise. In 1924, inflation was low, interest rates were stable, and the stock market continued to rise. In 1925, unemployment fell again and inflation was unchanged. In 1926, the stock market broke another record, unemployment declined sharply and the Revenue Act of 1926 sharply reduced tax rates’’.

“In 1928 the economy expanded briskly and continued to do so until the middle of 1929. And then the market crashed’’.

“To conclude, the classic case of positive fundamentals preceding the 1929 crash debunks the ‘weak fundamentals theory’ upheld by some economists’’.