The bad news is that the S&P futures are down 8 points and are trading 0.3% below fair value as market participants react to the nuclear-armed jawboning between the U.S. and North Korea. The good news is that the S&P futures are down only 8 points as the U.S. and North Korea go toe-to-toe with threats of their nuclear capabilities.
Everyone knows that a military conflict between the two countries would be calamitous, but frankly, if the market felt an actual conflict was going to happen, the S&P futures would be down more than 8 points, the 10-yr note would be up more than 13 ticks, and gold prices would be up more than 1.4%.
The takeaway from it all is that the increased tension between the U.S. and North Korea has provided a good excuse to take some money off the table from a market that is richly valued and has been trading with an elevated sense of complacency.
That complacency has been dialed back, though, in the last 24 hours. To wit, the CBOE Volatility Index hit a low of 9.52 yesterday and this morning it traded at 12.52 -- or 31% higher. The sharp reversal reflects a newfound desire to hedge investment portfolios against further downside risk.
That spike will be attributed directly to the North Korea situation, yet it probably has more to do with the notion that the North Korea situation is a cover for a pullback that has been gestating for a bit with the underperformance of the Dow Jones Transportation Average, the underperformance of the Russell 2000, the partisan dysfunction in Washington, and the lackluster response to what has been a very good earnings reporting season.
The confluence of those factors suggests the good news had been priced in for the most part; hence, the headlines surrounding North Korea serve as a bit of a wake-up call that the stock market was already exhibiting some pullback-ready signs.
The twist today is that "everyone" will now be expecting that pullback to unfold today, so don't be surprised if there is a subsequent effort to rally things back from early losses as participants push the narrative that the U.S-North Korea jawboning is more smoke than "fire and fury."
At the same time, take a look at what is going on with interest rates. They are dropping. Low rates have long been a source of support for the equity market. They aren't always the expedient to immediate stock market gains, yet they have regularly offered a rationale to buy on dips in the absence of a worst-case scenario coming to fruition.
The 10-yr note yield has dropped five basis points to 2.23% while the 2-yr note yield has also fallen three basis points to 1.33%. That disposition reflects some defensive posturing amid the geopolitical angst, yet one shouldn't dismiss either the angst about debt ceiling negotiations and a sense the Fed isn't going to raise the fed funds rate in the current environment as added factors supporting Treasury prices.
The second quarter productivity report certainly didn't incite any rate-hike fears. It showed nonfarm business sector labor productivity increased 0.9% (Briefing.com consensus 0.5%) following an upwardly revised 0.1% increase (from 0.0%) for the first quarter. In the second quarter a year ago, productivity was up 1.2%.
Unit labor costs, meanwhile, increased 0.6% (Briefing.com consensus 1.5%) after an upwardly revised 5.4% increase (from 2.2%) for the first quarter. The second quarter increase reflected a 1.6% increase in hourly compensation and a 0.9% increase in productivity.
The key takeaway from the report, which also included revisions for the first quarter 2014 through the first quarter 2017, is that productivity continues to be weak, which is an impediment for an increased standard of living. In fact, with the revisions, it was shown that productivity decreased 0.1% in 2016, which is the first annual decrease since a 1.0% decrease in 1982.
In other developments, Disney (DIS) failed to impress with its latest earnings report and outlook and is indicated 5.4% lower in pre-market action. That will be a drag on the Dow Jones Industrial Average and the S&P 500 consumer discretionary sector.
The real drag, however, is the recognition that the stock market's valuation is stretched, leaving it ripe for a pullback with, or without, a convenient headline catalyst.