Bear Market Rally Enters A Pivotal Week Of Trading

It has been another volatile trading week for markets. While the S&P 500 (SP500, SPX) recovered on Friday, taking the support of a Wall Street Journal news article and, most importantly, Japan’s intervention in the foreign exchange market to defend the yen versus the dollar to save the day.

Shares were positioned sharply lower Friday morning, with higher yields and the dollar screaming to its highest level in decades. Then a Wall Street Journal news article around 9:00 a.m. suggested that the Fed could begin to debate the pace of future rate hikes.

At that time, S&P 500 futures were down nearly 1% and were at a critical level of support. Had that support broken, it likely would have lowered S&P 500 futures to around 3,600. But then, at 8:52am, everything turned hard on the WSJ head.

Other than the headline, the article didn’t mention anything new, even noting comments made by Fed officials nearly a month ago. Anyone who had listened to Fed officials in the past month shouldn’t have been surprised.

In addition, big news came at 10:30 a.m. when Japan intervened to strengthen the yen against the dollar, pushing the dollar-yen pair sharply from around 152 to 146. That triggered a risky rally in equities. The expiration of the monthly options led to a sharp drop in put values ​​combined with the revival of traders buying out-of-the-money call options with zero days to expiration, and we had a solid rally.

Bond Yields Race Higher

Obviously, bond yields have risen sharply since the CPI report, and the bond market has significantly repriced the Fed’s final interest rates, and more importantly, the time it takes to reach that peak, equities have not repriced in the same way. For example, the 10-year interest rate has risen from 3.89% to 4.22% since 12 October. Meanwhile, the S&P 500 has risen from about 3,575 to 3,754, while the dividend yield for the S&P 500 has risen. cases from 1.84% to 1.74%.

As a result, the spread between the 10-year yield and the S&P 500 dividend yield has widened to 2.45%. That’s the highest spread since 2010, and more importantly, it appears to be at an inflection point. Historically, when the spread has gotten to this point, it has acted as a support or resistance. Is it possible that the market will return to a higher spread, with bonds and stocks returning to pre-financial crisis levels? Secure. But as with any technical formation or pattern, when the market encounters resistance, it pauses or reverses for a while while deciding what to do.

Drain

In addition, no additional liquidity has entered the market. Over the past week, liquidity has slipped from the market, with reserve assets falling about $50 billion to $3.05 trillion as use of the reverse repo facility increased. Reserve balances have been a strong indicator of where the S&P 500 has left off, with balances typically 5 to 15 days ahead of the index. More recently, the decline would indicate that the stock rally isn’t lasting on Friday.

stronger dollar

In addition, there are signs that the dollar index may rise from here, with the potential of a bullish continuation triangle. Since the end of September, the dollar index has been consolidating around the 110 to 114 region. In addition, the RSI has risen steadily, suggesting that the next major move in the dollar could be higher.

If the dollar collapses and pushes downward, that would be a risk sign suggesting equity could rise higher. If the dollar index breaks out as the chart indicates and moves higher, it would be negative for equities, resulting in a sharp decline.

Strong technical resistance

In addition, despite rising on Friday, the S&P 500 was unable to surpass significant resistance. The 3,750 region is key as that was around the July lows, and we’ve seen past lows as effective resistance on past rally attempts. For example, in early June, we saw the 4165 level act as a significant resistance level equaling the March lows.

If the S&P 500 can close past the October 4 highs, there could be another higher run of 3,900 and perhaps a gap of 4,108. However, failing to move beyond or close above 3,800 will likely result in a drop if not back to the lows, but through them.

For now, at least, there isn’t enough to suggest that last week’s stock market rally is real, and there haven’t been enough equity revaluations to reflect the recent rise in interest rates.

The next week will be a crucial one.