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The S&P 500 tumbled 1.78% on a heavy volume on Friday, as it was quadruple witching, when stock index futures, stock index options, stock options and single stock futures all expire on the same day. During the past several weeks, hedge funds have been liquidating stocks from their portfolio assets to raise cash in preparation for end-of-the-quarter or year-end redemptions. According to Bloomberg, firms including BlueCrest Capital Management, Och-Ziff Capital Management Group LLC and Mason Capital Management are feeling the heat, as patience from hedge fund investors has run out due to poor performances.
The WTI crude oil futures contracts January’16 [CL1.NYM], which are set to expire on Monday December 21, were quoted at $34.73 a barrel at the close on Friday, down another 0.63%. The S&P 500 has been recently trading along with the WTI crude price, as tumbling crude oil prices put more of a squeeze on small energy companies that sell high-yield, or junk bonds, to finance their operations. The Standard & Poor's Ratings Service recently warned that 50% of energy junk bonds are "distressed," meaning they are at risk of default.
On Wednesday, the U.S. Federal Reserve announced a quarter-point hike in interest rates, as expected. The Fed also said that they expect the fed funds rate to rise to 1.375% by the end of 2016, meaning that they will make at least four more quarter-point rate hikes next year. Although the rate hike decision was unanimous, it didn't necessary imply that the Fed is now in full-on hawkish mode.
According to Alan Blinder, Professor of Economics and Public Affairs at Princeton University and former Vice-Chairman of the Fed's Board of Governors, in a CNBC interview, Fed Chair Janet Yellen needed to get as unanimous of a decision as possible to gain credibility, particularly on the rate lift-off, and that had nothing to do with the Fed being hawkish or dovish.
At the press conference after the FOMC meeting, Yellen also made it clear that the pace of increases will be gradual and dependent on the quality of economic data. Although the Fed’s objectives are maximum employment and a 2% inflation target based upon core personal consumption expenditures (PCE), the Fed expects core PCE inflation to reach 1.6% in 2016 and 1.9% in 2017. The Fed statement sounds like, “one-and-wait” which is as close as you can get to what the market was expecting, which was a “one-and-done” for a considerable length of time.
According to the U.S. Department
of Commerce, the latest reading of the core PCE for October was
1.28% year-on-year. Thus, the Fed may have to sit and wait for a
while until inflation gets to their target level, especially
when the crude oil price is tumbling. Yellen thinks that the
crude oil price will find the bottom sometime and the inflation
will start rising. That is what she hopes.
The
Philadelphia Fed said on Thursday that its manufacturing index
in December came in at negative 5.9, compared to the
expectations of economists polled by MarketWatch of positive 1.
The index measures the manufacturing activity in the
Philadelphia-area based upon a scale where any reading above
zero indicates improving conditions. This is the third month in
the last four where the readings were below zero.
Earlier in the month, the Institute for Supply Management (ISM) reported that its manufacturing index for the U.S. was 48.6, missing the expected 50.5 reading of economists surveyed by Reuters. A reading below 50 indicates contraction in the manufacturing sector. Some analysts suggested that the U.S. industrial sector is already a technical recession.
The yield of the U.S. 10-Year Treasury Note jumped 3.38% for the week, to close at 2.204% on Friday, while the U.S. dollar index (DXY) surged 1.21% from the previous week, to close at 98.731, after breaking out the key technical head resistance at 98.14 on Thursday. The yield of the U.S. 2-Year Treasury Note skyrocketed 8.3% to close at 0.952% on Friday, driving the yield spread between the 10-year and 2-year Treasury Notes down 2.4% to 1.22 percentage points for the week, the lowest since February.
The 10-year/2-year yield spread has fallen over 30% since the beginning of July. Falling spreads may indicate worsening economic conditions in the future, resulting in a flattening yield curve. A very low or negative spread could signal an upcoming recession.
According to the Commitment of Traders (COT) data released by the Commodity Futures Trading Commission (CFTC) for the week ended December 15, there are 123,851 short positions of S&P 500 consolidated futures, traded on the Chicago Mercantile Exchange (CME) by leveraged funds, a decrease of 15,157 short positions from the previous week. This is compared to about 91,280 long positions, up 4,506 from the previous week.
The data suggested that hedge funds continued to cut back their short positions resulting in an increase in a net long positions of 19,663 contracts, worth about $9.91 billion, where contracts of S&P 500 futures are traded in units of $250.00 x S&P 500 index. In mid-October, hedge funds held a total of 192,998 short positions of S&P 500 consolidated futures.
The S&P 500 closed at 2,005.55 on Friday, down 0.34% for the week. The best performing S&P 500 sectors for the week were Utilities and Telecommunication services, which were up 2.75% and 1.41%, respectively. The worst performing S&P 500 sectors for the week were Materials and Information technology, which were down 3.06% and 1.31%, respectively.
Technically, the S&P 500 is gathering upward momentum as the index is trying to break out the trendline resistance (T/R) of the symmetrical triangle (SYM TRI) chart pattern. The rapidly falling yield spread, between the 10-year and 2-year Treasury Notes since July, signals that the U.S. economy is getting worse, not better. Hence, the index could break out if the U.S. dollar index pulls back further, toward the 94 level.
More downside risk for the dollar could be coming from the People’s Bank of China (PBoC), as the bank set the daily reference at 6.4814 yuan to a dollar on Friday, the lowest since July 2011, according to the PBoC’s China Foreign Exchange Trade System. Since China stunned financial markets by devaluing the yuan in August, the PBoC move would be to sell dollars to support the yuan. Thus far, there is no decisive intervention from the PBoC. Traders are speculating that the PBoC may move now that the FOMC has made their decision.
S&P 500 Summary: –2.59% YTD as of 12/18/15
Barclay Hedge Fund Index: +0.99% YTD
Outperforming Sectors: Consumer discretionary +7.39% YTD, Healthcare +2.99% YTD, Information technology +2.64% YTD, and Consumer staples +1.6% YTD.
Underperforming Sectors: Telecommunication services –3.7% YTD, Financials –5.5% YTD, Industrials –7.01% YTD, Utilities –9.99% YTD, Materials –12.58% YTD, and Energy –25.25%
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