- Rising yields show investors believe in Mester’s path to higher interest rates
- The three major moving averages extended the downtrend
- Nonfarm payrolls will create inflationary expectations
Last January I was still operating in a near-zero interest rate environment, so I interpreted rising yields as positive for equities. Yields increase when investors sell their bonds. In this environment, investors have been selling to switch to risky assets – increasing demand for equities.
However, I revised this outlook through January 31st after the Fed turned hawkish on January 27th. When yields rise in an environment of rising interest rates, the correlation between yields and stocks shifts from positive to negative. Higher interest rates would “make equities more expensive and mean Treasuries offer a safer and more attractive investment route than equities for some investors.”
Then, on March 27, stocks collapsed again, falling 15% to 5% as the Fed gave investors confidence that the economy was strong enough to handle aggressive tightening and that the central bank would finally fight runaway inflation. However, I reiterated the risk of sharply rising yields and predicted that the top three moving averages would soon join in a bear market.
And September suffered its worst monthly fall since March 2020’s ignominious sell-off, when the world panicked over a scary global pandemic, and on the same subject – steadily rising interest rates.
However, the S&P 500 capped its third straight quarter of losses for the first time since 2009 after the infamous 2008 crash that triggered the Great Recession. At the same time, US Treasuries saw their sharpest outflow in three months, pushing yields down to their highest in a decade, with 10-year notes hitting 4% on Wednesday.
10-year notes rose for nine straight weeks, their longest winning streak since April 1994, according to Refinitiv data. While last week’s long upper shadow and the previous week’s resistance point to a possible fall in yields, the chart below shows a bottom that threatens further upward movement in yields and interest rates. If this outlook holds out, I expect the same theme will continue to push equities lower: Higher interest rates make equities expensive, while higher yields present an attractive, safe alternative.
US Treasuries long term chart
On Friday, Fed Vice Chair Lael Brainard acknowledged that her bank is concerned about emerging market vulnerabilities and the rising risk of instability for three reasons:
- Increases the debt of poor countries when they borrow money in dollars.
- They are forced to raise interest rates to defend their currency, slowing their economic growth.
- We export America’s inflation to other countries because commodities are priced in dollars.
Bloomberg called Brainard’s admission of the need to monitor the impact of borrowing costs on global market stability “concerns allayed on Friday”. I humbly agree with this assessment. All four US indices closed near the session lows as there were only sellers and no buyers at these prices. After falling within an hour of Brainard’s speech, yields rebounded and closed near session highs. I think a stronger impression on investors came from Brainard’s comments about the inadvisability of exiting the fight against inflation prematurely. And the fact that even a centrist like Brainard is pushing for more rate hikes is telling. On Thursday, Loretta Mester, President of the Federal Reserve Bank of Cleveland, expressed the same sentiment. Mester will speak again Tuesday at 9:15 ET and I expect volatility around her speech.
The next big sign in terms of inflation will be Friday’s Nonfarm Payrolls. Will America have created more jobs and raised wages further? If this is the case, it will lead to higher inflation as consumers keep pushing demand and prices higher. Economists are expecting another , remaining at 3.7%, just above a five-decade low. If proven correct, while that would be the smallest job gain since late 2020, it would still be higher than the five-year average. This continued demand for labor continues to support wages and fight the Fed’s path of lowering inflation by raising interest rates, forcing it to become even more aggressive.
The bulls expected the recent rally to have taken the market to the bottom. There is a “50% indicator” when a rally halves bear market losses, which are considered the perfect record for calling bull markets. However, I am a simple analyst. I followed the trend lines, highs and lows, which is why I held on to my bearish claws. Now that the three primary US indicators are making new lows, I am reaffirming my August S&P 500 forecast at 3,000. Since then, Mike Wilson, Morgan Stanley’s chief US equity strategist, has echoed that sentiment, saying the S&P 500 could fall into the low 3,000 area.
Robert Pavlik, senior portfolio manager at Dakota Wealth in Fairfield, Connecticut, also echoed my prediction, saying he sees a worst case 3,000 for the S&P as a support level. However, I wouldn’t be surprised if the S&P 500 index and the other averages continue to fall. While inflation isn’t under control and the Fed isn’t stopping raising rates and yields aren’t falling, I expect stocks to continue falling. An average bear market sell-off is 39% over 20 months, which is another 19% drop.
All four major US moving averages have developed flags. The S&P 500 is the only one whose flag isn’t tipped up, which makes me less confident in its potency, although Martin Pring writes in his Technical analysis explained that flags don’t have to be slanted. The Russell 2000 is the only flag that is not finished. The S&P 500 Index is the only one to find support above its 200-week ma, while the others fell below theirs two weeks ago.
The (flat) flag of the S&P 500 Index implies a drop to 3,443.36 based on the flagpole and based on the previous sell-off which could be even as fast as the next three days.
Disclosure: The author has no position in the securities mentioned in this article.
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