Russell 2000 small cap rally reverses, oil and bond yields resume upward track

The Russell 2000 led equity markets down, reversing recent strength, as Mid-East tensions, a rising oil price, and higher bond yields undermined equity market fundamentals. The US economy is now outpacing China in a remarkable turnaround. US corporate earnings are a mixed bag. Bond yields and the oil price continue to rise. In domestic politics, the continued absence of a House speaker ahead of another possible US government shutdown is ominous.

Bottom-line: Risk-off

TODAY’S MAJOR NEWS

Equity markets fear increasing Mid-East tensions, Bonds fear inflation

Any chances to sustain a rally in the equities are constrained by increasing tensions in the Middle East following the massive explosion at a Gaza Strip hospital that killed hundreds of Palestinians and inflation fears roiling bond markets. Assessing who destroyed the Gaza hospital will take weeks, fueling anger, and many in the region will refuse to accept a final explanation. Bond markets continue one of the most extended bear market price declines since the early 1980s, with 10- and 30-year yields hitting 4.9% and 5.0%, respectively. An escalated Mid-East war directly impacts the output of crude oil and natural gas, boosting the oil price but negatively impacting equities and bonds.

US earnings are a mixed bag, but growing disappointments

What's becoming clear in Q3 earnings is a clear distinction between winners and losers in revenue and profit reporting. The ear of universal good news from the corporate sector is slowly ending. Netflix surged in after-hours trading on much higher third-quarter subscriber numbers and after announcing higher prices in the US, UK, and France. ASML fell after the Dutch chip equipment maker as it warned about slowing customer orders and flat sales. Nvidia fell after the US tightened curbs on AI chip technology exports to China. Morgan Stanley fell after reporting a significant drop in investment banking and trading profits. United Airlines fell after the airline warned about the impact of geopolitical conflicts and higher fuel costs.

The US economy is growing faster than China

In the third quarter, the US economy will likely grow faster than China in a remarkable leadership change. The Atlanta Fed's real-time US GDP growth estimate now estimates 5.4% year-on-year for the third quarter, while China just reported 4.9% growth for the same period. Admittedly, China’s report beat downbeat growth expectations as low as 4.0%.

The Chinese consumer needs more confidence in the economy to make significant purchases like property, but they will spend on immediate needs. The property sector makes up more than 20% of the GDP, with many property companies facing possible defaults in the coming months.

• Chinese retail sales rose 5.5% in September, up from 4.6% growth in August, with solid gains in catering and goods
• The property sector continues to hurt, with properties sold down 4.6% year-to-date and the value of property sales down 7.5% in the same period
• Unsold new houses were up 19.7% year-on-year despite official policies designed to support the sector

US crude oil inventories tighten

As if to highlight the global under-supply position spurring crude oil prices, US commercial crude oil and product inventories (excluding the Strategic Petroleum Reserve) are at the bottom of recent ranges:

• Crude oil inventories fell by 4.5 million barrels in the week ending October 13, putting them 5% below the five-year average
• Gasoline stocks dropped by 2.4 million barrels, slightly above seasonal levels for mid-October
• Distillate stocks decreased by 3.2 million barrels, 12% below levels typically seen this time of year
• Ethanol stocks slipped lower to 21.1 million barrels in the week ending October 13, down from 21.5 million the previous week, at the lower end of seasonal levels for mid-October

Mixed US housing start data

The supply of houses remains tight, although buyers remain too wary of today’s high rates and economic uncertainty to move. Housing start data today beat expectations, highlighting the absence of new home supply.

• Housing starts rose to an annualized rate of 1.358 million in September, up 7.0% from 1.269 million in August, but below expectations that they would increase to 1.394 million units
• Permits issued to start new housing projects fell to an annualized rate of 1.473 million, down 4.4% from 1.541 million last month but above expectations of 1.450 million permits

TODAY’S MAJOR MARKETS

Russell 2000 leads market decline

• The broadly-based Russell 2000 turned tail after recent strength, falling 2.2%, while the Nasdaq and S&P 500 fell 1.6% and 1.3%, respectively
• Foreign equity markets fell sharply overnight, led by a 2.0% decline in the DAX, 1.1% in the FTSE 100 and the Nikkei 225 being unchanged
• The VIX, Wall Street’s fear index, rose to 19.2

Bond yields continue to increase, dollar rallies

• 10-year yields traded up to 4.90%, with 2-year yields unchanged. Long-dated 20-year bond yields crossed the 50.% mark, a yield last seen in September 2010
• The dollar index rose 0.3% to 106.6
• Versus the dollar, Sterling and the Euro were off by 0.3% and 0.4%, respectively, while the Yen was unchanged

Oil and gold rally

• Crude oil prices resumed their bullish trend, up 1.9% to $88.3 per barrel
• Spot gold prices rose 1.5% to $1,964 per ounce, while silver prices were unchanged at $23.0 per ounce
• Selling emerged in the soybean market when the lead November contract was unable to uncover significant buy orders above $13, while the same was true for the $13.20 level for the January contract
• Corn and wheat prices are generally in the green with modest gains at midday, although that still leaves them primarily within their recent trading ranges

Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com

Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com