Five consecutive weekly declines end; will the U.S. stock market usher in a turning point?

Author | First Financial Fan Zhiqing

Even as the Middle East conflict continues, U.S. stocks have finally seen their first weekly bullish candle since mid-February this year, as investors closely watch the outlook for the conflict.

For investors, the question is whether this is merely a technical rebound after an oversold selloff, or the start of a longer-lasting recovery—next week may provide clearer clues.

The outlook for Fed rate cuts looks bleak

Recently, the data released by the United States has been overall positive. Employment, retail sales, and the consumer confidence index all came in better than expected, but the Chicago PMI and the U.S. March services PMI have sounded an alarm for the economy.

In March, nonfarm payroll employment growth increased by 178,000, recovering from the unexpected decline in February, and the unemployment rate also fell from a recent high to 4.3%. Private-sector hiring also stabilized and rebounded: ADP employment rose by 62,000 in March, beating the market expectation of 40,000. The Fed’s JOLTs job openings fell from 7.24 million in the prior month to 6.882 million, but still slightly above the expected 6.85 million.

On the consumption side, February retail sales rose 0.6% month over month, a clear rebound from January’s -0.1%, and it also beat the market expectation of a 0.4% increase. Core retail sales grew 0.5%, higher than January’s unchanged month-over-month and above the expected 0.4% increase. Meanwhile, the Conference Board consumer confidence index rose by 0.8 points to 91.8 in March, better than institutional expectations of 87.5.

The unfavorable side is that the Chicago PMI for March fell to 52.8, below the market expectation of 54.0. The final March services PMI print was 49.8, breaking below the boom-bust line again for the first time in three years. The Federal Reserve Bank of Atlanta this week further lowered its real-time estimate for first-quarter gross domestic product (GDP) to 1.6% from 2.0% from last Friday. However, the market may still need to wait a few more weeks to obtain economic data that includes the impact of the Middle East conflict, and then reach a conclusion.

Schwartz (Bob Schwartz), a senior economist at Oxford Economics, told a First Financial reporter that although the nonfarm employment data performed better than expected, the figure significantly overestimates the sustainable pace of employment growth. With the end of strikes, rebound effects after seasonal factors and severe cold weather may boost employment growth in some industries. While the unemployment rate fell slightly, the underlying subcategory data showed weakness: both the labor force population and employment in household surveys declined. As the conflict shock causes the labor market to soften, the unemployment rate is expected to tick up slightly in the next period.

This week, yields on U.S. Treasuries across intermediate- and long-term maturities fell back from recent highs, and the yield curve showed some degree of steepening. Compared with last Friday: the 2-year Treasury, closely tied to rate expectations, fell by about 14 basis points to 3.794%, and the benchmark 10-year Treasury yield fell by about 12 basis points to 4.305%.

Market expectations for the Fed’s next step policy remain unchanged. Pricing in federal funds rate futures shows a probability of nearly 80% that the rate will be held unchanged in December. As of now, the probability of a Fed rate cut will not exceed the 65% threshold until July next year.

Schwartz believes that due to the conflict, the downside risks to the labor market have increased somewhat. As individuals begin to increase spending on gasoline, which starts to crowd out discretionary consumption, the conflict will begin to affect retail starting from March. However, he leans toward the Fed ignoring the one-off inflation lift caused by rising oil prices and cutting rates twice within the year to guard against further weakening in the labor market.

Can the market stabilize

After a bleak first quarter, the three major U.S. stock indexes recorded the largest weekly gain in four months and ended the prior streak of six consecutive weeks of declines. Investors are looking for reasons and betting that the Middle East conflict could be headed toward an end.

In terms of sector performance, according to Dow Jones Market Statistics, the communication services sector led the gains, jumping 6.4% for the week. The technology sector followed, up 4.6%; the real estate, financials, and materials sectors were also strong, with gains of more than 3% each. Industrials, consumer discretionary, and healthcare rose more than 2%; utilities and consumer staples also edged higher. Energy was the only sector to finish lower, sliding 5.3% for the week.

Doug Parsons, chief economist at BMO Capital Markets in Montreal, said in a report: “The market is almost entirely driven by every movement in the U.S.-Iran conflict, especially every fluctuation in oil prices. This surge in oil prices triggered a record 26% increase in U.S. retail gasoline prices.”

It is worth noting that although near-month crude oil futures prices have surged sharply, with WTI crude rising to about $111 per barrel and the international benchmark Brent crude approaching $108 per barrel, the pricing for the two crude oil futures October contracts is around $80 per barrel, indicating that the market expects the supply disruption to be temporary.

“Right now, neither bulls nor bears in the stock market have a clear direction, but the October oil price indicates that the market believes this crisis will end before the autumn,” said Michael Antonelli, a market strategist at Baird.

In its market outlook, Charles Schwab wrote that the stock market has just gone through another week of extreme volatility.

“Investors are still faced with many unresolved questions: How long will the conflict last? How high—and for how long—will oil prices rise? Will the United States target Iran’s energy infrastructure? Will the United States dispatch ground troops? Ultimately, what is the net impact on global economic growth and growth in corporate earnings? The market hopes to reach a relatively peaceful resolution with the least human casualties and limited damage to global economic growth, but until then, the stock market and headline news are likely to remain sharply volatile.” The outlook said that next week the market will see two monthly inflation reports (the Consumer Price Index and the Personal Consumption Expenditures Price Index), but these data will likely be overlooked because they are lagging indicators, and inflation in the coming months is likely to rise further due to higher energy prices.

The outlook also believes that given the potential escalation of military strikes, it is difficult to provide further forecasts when stock price action is driven by conflict news rather than economic and technical indicators. “However, last Thursday seemed to be the first time the negative correlation between the S&P 500 and oil prices was challenged—WTI crude jumped 11% and the S&P 500 fell only 0.10%. That may be a positive sign for the bulls, but if the situation escalates next week and oil prices rise further, can the stock market remain resilient? That could become a gauge for near-term direction.”

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Editor: Song Yafang