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Market Brief – Tuesday 2/5/19

Investors quickly shrugged off Google’s earnings report and went back to buying stocks. During long expansions, investors become trained to ignore any poor earnings or economic news and to just buy stocks. While the S&P 500 is facing another overhead resistance level and its 200-day moving average, U.S. Treasury bonds have not provided any confirmation to this recent equity rally. In early trading, Treasury yields reversed most of yesterday’s rise.

This post-Christmas rally has left traders perplexed to its strength, as equity flows have been negative, indicating investors are selling this rally. As to who is buying, the computer algorithms have been, which are likely being front-run by the high-frequency trading algorithms. With the lack of confirmation from equity flows and the bond market, this equity-rally speaks to the speculative nature of the U.S. stock market.

It is likely most investors and traders chasing this rally are using speculative tools, such as option contracts, and are shorting volatility to get stock prices to rise without committing to a direct purchase of any shares. Their hope must be to lure retail investors back in, who sold in late December and have sat on the sidelines ever since.

The ISM Non-Manufacturing (or Services) survey decline from 61.2 to 59.7, showing the services sector is still running strong. The surprise in the data was the huge drop in new orders and new export orders. New export orders fell by the third largest amount since the Great Financial Crisis.

Last night Fed Chairman Powell met with President Trump over an informal dinner, where he reiterated any monetary policy decisions will be based on the incoming economic data, according to a Federal Reserve press release.

This morning, Bill Dudley, a member of the Federal Open Market Committee, released a short paper titled, “Stop Worrying About the Fed’s Balance Sheet.” In the paper, Dudley makes a strong case as to why the Fed’s balance sheet unwind has had nothing to do with the recent reduction in economic activity or the fourth-quarter drop in stock prices.

He also reiterated what Powell said at the last FOMC press conference, is that the Federal Funds rate is the primary policy tool and the balance sheet will only be used if the Fed needs more ammunition beyond lowering the Federal Funds rate to zero. Investors who have been buying stocks in hopes the Fed will capitulate on their balance sheet unwind clearly did not pay close attention to the Fed’s recent press conference. Until further notice, the balance sheet unwind will continue.

Today’s 3-year $38 billion Treasury auction saw strong demand with foreign investors increasing their take from 41.9% in January to 45.7% of the offer. Direct, or domestic bidders, took 18.5% of the offer, leaving securities dealers with 35.9%.

Stocks closed higher ahead of the State of the Union address on very light volume as investor remain hopeful. A month ago, stocks started to rally on hopes of a dovish Fed, an end to the trade war, and higher corporate earnings. The Fed didn’t turn dovish, the trade war is not over, and earnings only looked good because analysts downgraded their earnings expectations just prior to release.

Of the small number of companies who have provided forward guidance, approximately 80% of them offered negative forward guidance for the coming quarter. Investors clearly don’t believe this, as they have been buying risk assets.

Treasury yields finished the day lower and are expected to fall tomorrow, as the Fed is planning to offload -$14.2 billion from its balance sheet through tomorrow’s 10-year Treasury auction.

The American Petroleum Institute, who is generally wrong, reported crude inventories as Crude: +2.514M Cushing: +889K Gasoline: +1.731M Distillates: +1.141M. Those bullish on crude oil will be hoping for a much different set of numbers when the EIA reports tomorrow morning, as the markets have been expecting draws across the board.