S&P 500; US Indexes Fundamental Weekly Forecast – Focus on Treasury Yields and Fed Speakers This Week

The major U.S. stock indexes fell sharply last week with the S&P 500 Index and Dow Jones Industrial Average posting their worst week since January 2016. This was the first weekly lower close in 2018, following four weeks of solid gains.

For the week, the benchmark S&P 500 Index settled at 2762.13, down 3.9%. It’s up 3.3% for the year. The blue chip Dow Jones Industrial Average finished at 25520.96, down 4.1%. So far, it’s posted a 3.2% for 2018. The tech-based NASDAQ Composite closed at 7240.97, down 3.5%. It is now up 4.9% for the year.

Traders laid most of the blame for the sell-off on the rise in interest rates as the benchmark 10-year U.S. Treasury yield crossed an important threshold at 2.70%. However, there were other factors.

Firstly, an improving economy and its impact on Fed policy. The jobs report, for example, came in better-than-expected with the headline number hitting 200,000. The most impactful portion of the Non-Farm Payrolls report, however, was the uptick in wages.

While this is a broader positive for the economy, it also signals potentially firming inflation ahead, raising worries among equity market investors that the Fed may be more aggressive with interest rate hikes this year.

Secondly, strong earnings have left investors wanting for more. This means that even with positive earnings, investors could be disappointed in the short run if their bar of expectations is set much higher.

Thirdly, bull markets get tired and investors do get exhausted from chasing them higher. Words like “overbought” and “overextended” get thrown around and investors start thinking about value.

Forecast

Momentum is going to be a major concern for investors early in the week because of the presence of strong downside momentum at Friday’s close. The markets are going to have to “clean-up” a little before I think we’ll see a true trend develop.

There is only one major economic report this week. It is the ISM Non-Manufacturing PMI. This report could generate a mild reaction in the markets, but I think bigger moves and increased volatility are likely to be generated by a pair of Fed speakers on Wednesday.

Speeches by FOMC Members William Dudley and John Williams will be watched closely for their opinions on the Fed monetary policy statement and inflation.

In early January, Williams said the Federal Reserve should raise interest rates three times this year given the already strong economy will get a boost from tax cuts, and can tighten more or less aggressively if needed.

He also said, “I’m not worried about inflation suddenly taking off” and “Something like three rate hikes makes sense to me” this year. Given the fresh economic data, let’s see if he changes his tune to more hawkish. If he does, this could pressure the stock market even further.

Dudley said earlier in the month that the risk of an overheating U.S. economy in the next few years, partly fueled by tax cuts, reinforces the case for continued gradual interest-rate increases. Stocks could be pressured further if he gets a little more aggressive with a call for additional rate hikes.