The “Wild Card” That Could Kill The Bull Market This Week

The post-election rally paused last week after peaking on March 1, the day after President Trump’s speech to a joint session of Congress. Investors are now dealing with two key concerns that may temper their animal spirits – rising interest rates and falling oil prices. (More about those in a moment.)

But there is another wild card that could throw a wrench into the best-laid plans of stock market bulls in the next week. And right now, no one’s talking about it.

While all eyes have been focused on rates and oil, we’ve heard very little about this potential game-changer…

We’re About to Raise The Federal Debt Limit Again – And That’s Bad News

We’ve heard very little about the fact that the government is about to hit its borrowing limit on March 15, but investors should keep an eye on this inconvenient truth.

On March 16, the Treasury will begin taking extraordinary measures to stay under the government’s $20 trillion borrowing limit until Congress can extend it.  While such extensions used to be routine, they have taken on a political life of their own in a sharply partisan Washington, D.C.  It may be hoping too much to think that that the first debt extension of the Trump presidency will go smoothly.

While a government shutdown would be a non-event since vital services would continue and much of the government should be wiped off the face of the earth before it does any further damage to human freedom and dignity, the media will start focusing on it shortly. Whether the markets will care or not remains another question – they don’t seem to care about much that matters these days.

But they are starting to pay a bit of attention to the fact that interest rates are going to rise and the bottom is falling out of oil prices. And both of those factors could throw a serious wrench into the bull market this week as well.

The Potential Damage from A Rate Hike Could Be Huge

This week promises to bring another 25 basis point hike in interest rates by the Federal Reserve.  While long overdue, this will be the second consecutive quarterly rate hike by the feckless Fed and markets are raising the odds of another increase in June, which would be the third straight quarterly increase.  With this week’s hike a foregone conclusion (and if for some reason the Fed chickens out, President Trump should demand the immediate resignations of every member of the Federal Open Market Committee), futures markets are already pricing in a 56.3% chance of a June hike and a 60% chance of a third increase in December, according to Bloomberg.

While February’s employment report was not nearly as positive as portrayed by the woefully economically ignorant press, the economy long ago met the Fed’s stated targets for employment and inflation and can handle higher rates.  The Fed is at least two years behind the curve, but who’s counting?

The question, however, is how stock market psychology will be affected by the Fed’s new tightening mood.  After all, the Fed has supported stocks for a decade with every conceivable conventional (i.e. low rates) and unconventional (QE) tool at its disposal.  While it will be difficult to break investors of the belief that the Fed will jump to their rescue at the first sign of trouble (there are already reports of it readying a new $1 trillion QE plan when the market falters), the reality is that right now the Fed is taking away the proverbial punch bowl and raising rates, something that historically leads to market reversals.  If the Fed does something it never does and actually keeps its word and raises rates three times in 2017, the Fed Funds rate will end the year at 1.25-1.50%, still low but high enough in a zero/negative interest rate world to seriously damage fixed income returns.

We are starting to see the potential damage from higher rates.  The yield on the benchmark 10-year Treasury jumped from a recent low of 2.31% to 2.575% last week, close to its post-election high and twice its post-Brexit low of last summer.  Junk bonds took it on the chin last week after spreads dropped to their mid-2014 lows (after which junk bonds suffered serious losses driven by the energy bond rout that continued through early 2016).  Last week, the iShares iBoxx $ High Yield Corporate ETF (HYG) lost a huge 1.9% and many closed end high yield funds lost more than 1%.  Junk bonds were hit by a double whammy – higher rates and falling energy prices, which hit energy sector bonds hard as memories of the recent energy bond rout remain fresh in investors’ heads.

And that brings us to the second concern that ended stocks’ six-week winning streak last week.

When Oil Starts Sliding, Markets Start Crumbling

Last week, oil took a pounding with WTI Crude dropping below $50/barrel for the first time since late November 2016. WTI Crude fell 9.3% last week, bringing its 2017 decline to -13.2%; the S&P 500 Energy sector is down 9% year-to-date.   Oil dropped on concerns about oversupply in the U.S. (US data showed domestic supplies rose for the ninth consecutive month in February to a record 582 million barrels) and fears that OPEC’s production agreement is not yet reducing supply (OPEC members made wishy-washy statements regarding production cuts but refused to pledge to renew their six-month agreement once it expires in May).

On Wednesday, March 8, benchmark WTI and Brent both fell a sharp 5%, their biggest one-day drop since February 2016. They continued to fall through the end of the week, something that is not unusual in momentum-driven commodity markets. Oil prices doubled in 2016. But after initial hopes that they would continue their upward climb, early indications are they may head back to the low $40s.

This combination of worries led the Dow Jones Industrial Average to drop 102.73 points or 0.5% on the week to close at 20,902.98, its largest decline this year while the S&P 500 fell 0.4% to 2372.60 and the Nasdaq Composite Index lost 0.2% to 5281.73, its first loss in seven weeks.

While these losses were minor, market internals are poor.  Retail stocks I’ve recommended as shorts such as Macy’s (M), GNC Holdings (GNC), Sears Holdings (SHLD), Fitbit (FIT) and GoPro (GPRO) and others are trading poorly.  Other recommended shorts such as Caterpillar (CAT), Kellogg’s (K), and Chipotle Mexican Grill (CMG) are limping along.  Financials were weak after Treasury Secretary Steve Mnuchin said the Trump administration plans to keep Glass-Steagall in place (a good idea).

Markets are trading for perfection in a highly imperfect world and in that world, many stocks are in trouble. Investors should plan accordingly.  Trees don’t grow to the sky and neither do markets.

Sincerely,

Michael

5 Responses to “The “Wild Card” That Could Kill The Bull Market This Week”

  1. Ronald Kaminski

    I think we are in a gigantic bubble that Obama purposaly kept high by government spending.In the last two Down turns the President had just been elected,right before the market fell.I think the market will fall back to 7 or 8ooo.And when it does the sides of the market will fold in.The government does not have the money to bail out banks,therefore causing the big banks to fail,and smaller banks will begin to show.It will take a decade to turn the corner.It Will Not Be Pretty

  2. I have been researching many viewpoints on where the market is heading. You have brought all of the components together in a realistic way. I believe that the economic decisions are made are not based on reality, otherwise the wisdom of the nay sayers would win out. There are some people who believe the stock market can go much higher. It is impossible to make good decisions with such a wide range of opinions. I want to ask a question about the Fed going to a digital currency which has been discussed behind the scenes. I am thinking that this is a ploy to make gold irrelevant when discussing debt-ridden currencies. What is your opinion on this topic?

  3. Mr. Lewitt, I’m just trying to get this straight, but I’m sure it could be considered nit-picking. What did Treasury Secy Mnuchin say? Glass-Steagall is not in place- repealed in ’99 or ’00 by Pres Clinton. From 19 Jan 2017 Business Insider: “I don’t support going back to Glass-Steagall as is,” Mnuchin told the Senate Finance Committee. “When we talked about policy with the president-elect, our view is we need a 21st century version.” Please clarify.

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