October 12, 2016

Stocks rebounded modestly at the open (Dow +12 pts; SPX +.3%), led by the defensive sectors (utilities, real estate, consumer staples). Energy is lagging on lower oil prices. Biotechs are down again, and the Nasdaq Biotech Index is off nearly 20% so far this year. The VIX Index is up to nearly 16, suggesting higher expected volatility in stocks in the next 30 days. WTI crude is trading at $50/barrel. Oil could trade lower in the near term once traders realize the OPEC production freeze deal is more about words than action. The dollar is stronger on the day (but still down slightly on the year). Bonds are selling off again and yields are rising. The 10-year Treasury yield ticked up to 1.79%. And it does look like the 10-year bottomed convincingly back in early July so we could definitely see rates head higher. Remember, the 2016 high for the 10-year is about 2.2%. 

Wall Street is convinced the Federal Reserve will soon resume interest rate hikes. The dollar and interest rates have been rising in anticipation. The 2-year Treasury yield is up over 1% this morning and we haven’t seen that since early June. The PowerShares DB US Dollar Index fund (UUP) is up 2.7% in the last month. The dollar is back up to March levels relative to a basket of foreign currencies. Now this comes despite the fact that the economy isn’t really accelerating. The Atlanta Fed’s GDPNow economic growth forecast is 2.1% for the third quarter. That’s ok, but not great. The Citigroup Economic Surprise Index has fallen negative in the last month, meaning on balance more economic data is coming in weaker than expected. And finally, inflation is well contained. The Fed’s preferred inflation gauge, Core PCE, is showing 1.7% y/y growth. The overall Consumer Price Index (CPI) is up 1.1% y/y. Neither of these measures is close to 2%, the Fed’s traditional target. And besides, Fed Chair Yellen has said monetary policy doesn’t need to tighten until it’s clear that inflationary trends are sustainably above the target. I concede the job market has seen amazing improvement and we are basically back to full employment. But the US economy and global financial system are still too episodic to warrant much monetary tightening. Fed officials are (again) crying wolf. 

As mentioned above, we’re seeing the healthcare sector (and especially biotechs) lose altitude. Believe it or not, healthcare is the worst-performing sector in 2016, and the only sector with a negative return (-2.3%). Some big pharma companies like Pfizer (PFE), Abbvie (ABBV) and Merck (MRK) are up year-to-date, but the iShares Pharma ETF (IHE) is down over 9%. And again, biotechs as a group are down 19%. The three biggest biotechs (Gilead Sciences, Celgene and Biogen) are all down more than 25% from their respective all-time highs. A portion of the blame can be traced to tweets by Hillary Clinton beginning a year ago threatening government price controls on drugs. And now, we’re hearing that traders are again selling the sector as it seems more likely that Democrats may not only win the White House but also the House of Representatives.

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