Recently, it seems equities markets are fixated on a single issue: the relentless rise in interest rates.
That’s for good reason. The higher interest rates are pressuring equities lower, and in the short term, it’s nearly impossible to escape. Over time though, that relationship doesn’t necessarily hold true. But until rates stabilize, equities markets will experience weakness. So, there’s some good and some bad happening right now.
The lack of strength was exemplified in weak market rebounds on Sept. 27-28, as well as the way investors sold into good inflation news even after markets opened positive on Sept. 29. From a tactical perspective, this makes the S&P 500’s* 200-day moving average of 4,199 a key indicator in the short term.
To put rate increases into context, as of this writing, the recent high in the 10-year Treasury yields of around 4.688% was the result of the 17-basis-point surge in little over 24 hours. That’s the equivalent of an 800-point selloff in the Dow Jones Industrial Average#:
In the search for optimism, we can take solace in how the Treasury market has reversed course after other major uptrends this year. Each prior peak above saw swift downturns in yields thereafter:
- May 2023, -31 basis points, from 3.86% to 3.57%
- July 2023, -35 basis points, from 4.09% to 3.74%
- July 2023, -25 basis points, from 4.21% to 3.96%
- August 2023, -30 basis points, from 4.36% to 4.06%
What’s causing this? History shows some similarity to December 2018, when the Federal Reserve overtightened in a good economy. So, it’s reasonable to wonder if the Fed is in danger of going to another extreme now since its present pace of $95 billion in quantitative tightening is the highest ever.
As we've all learned, unfortunately the Fed can override the stock market with its open market operations. Thus, it becomes a driver of the surge in bond yields.
It also doesn’t help that the U.S. has continued to have a budget deficit every year since 2001. This all means the U.S. Treasury will issue record levels of Treasuries at the same time the Fed is conducting aggressive quantitative tightening and, at the moment, contributing to the surge in yields from a supply and demand standpoint:
Two other contributing factors are at play. One is higher real interest rates. The other, and perhaps most important factor, is momentum. Rising rates are attracting more short selling, which leads to higher yields.
And with a strong move like this on higher yields, investors don’t want to stand in the way of this surge – there is a significant amount of embedded leverage in the Treasury market. But as we all know, when a “trade” becomes obvious and has sufficient momentum to seem unstoppable, that’s when it could reverse.
This viewpoint is reflected in the latest trading commentary from the JP Morgan Chase Fixed Income trading desk. Those particular clients are the most short they’ve been since April 2023, which is historically a pretty solid contrarian indicator:
This rate issue is the contributing factor to a lot of fear and pain in recent weeks. But have stocks reached a point where they could reverse course in the short- or intermediate-term? The quick answer is yes, but only if rates stabilize. We may be close but we're not quite there yet:
Equities are a tough buy when investors are fearful of rising rates, even if the shift above is arguably where rates should be fairly valued based on previous breakpoints:
Understanding the historical data and bond market technicals, let’s turn our attention to MAPsignals’ Big Money Index (BMI), which is a 25-day moving average of “big money” professional investor buys versus sells. Through this lens we can potentially begin to see a path out of this oversold equity market.
As of this writing the BMI is 31.2%. On Sept. 28, 2023, it was 35.7% and our friends at MAPsignals conducted a thought experiment. They plugged in forced selling of 100% for every day after Sept. 28. At that rate, the BMI would hit oversold levels late last week:
No matter how you slice it, markets have been ugly lately. Most metrics, like the BMI, are nearing oversold levels. But at least with the BMI, that’s an opportunity because forward returns since 1990 are largely positive:
A good visual representation can be seen in the past 12 months. When the BMI went oversold, markets rose soon after:
It’s key to note, in each instance of the BMI hitting oversold, higher lows were established thereafter as well. In other words, the market foundation keeps rising. This is healthy from a long-term perspective.
Still, we can't ignore the present. Based on the current data and precedent, it’s fine to expect a strong rally with concentrated buying potentially beginning in the second half of October. Remember, fear and greed are still the lifeblood of the stock market.
To conclude, the data says we are in a BMI downdraft. That typically means near-term pain followed by multi-month gains. Time will tell if that happens again.
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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
# The Dow Jones Industrial Average is a stock market index of 30 prominent companies listed on stock exchanges in the U.S.
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