A rising 10-year Treasury yield is hurting stocks … why it’s heading higher … is the S&P in for a meaningful correction or not? … what Luke Lango is watching to confirm a bullish breakout
If you want to know why the stock market has been struggling since the end of December, there’s just one chart you need to consult…
The 10-year Treasury yield.
For newer Digest readers, the 10-year Treasury yield is the single most important number for the global economy and investment markets. All sorts of interest rates and asset values are directly impacted by whether the 10-year Treasury yield rises or falls.
For stocks, a higher yield is typically a headwind to prices for two main reasons.
One, when analysts estimate a stock’s value, they use what’s called a “discount rate,” which is heavily influenced by the 10-year Treasury yield. Given the math involved, the higher the discount rate, the lower the net present value of a company’s future cash flows – which means lower stock prices.
Two, a higher 10-year Treasury yield entices some investors to pull their money out of stocks to benefit from this “risk free” higher yield (it’s risk free when a government bond is held to maturity). That put downward pressure on stock prices.
Below is a chart of the 10-year Treasury yield over the last six months. As you’ll see, after falling as low as 3.78% the day after Christmas, this yield has been on the move higher.
As I write Thursday morning, it’s back up to 4.12%.
To see the impact on stocks, let’s now look at this same chart but add the S&P 500
Below, the S&P is in green while the 10-year Treasury yield is in black. We’re looking at the last six months, stopping our analysis on December 27th (we’ll analyze after the 27th in a moment).
Note how the rising 10-year yield pushed stocks lower through the summer and fall. But when this yield crashed in late-October, it fueled the monster surge in the S&P that we enjoyed over the holiday season.
As noted a moment ago, in late-December, the 10-year Treasury yield began climbing again. And per usual, this created a headwind for stocks.
Here’s how that looks.
Frankly, the fact that the S&P has only moved sideways while the 10-year Treasury yield has jumped more than 30 basis points is a big win.
What’s behind this reversal in the 10-year Treasury yield and where is it going?
The 10-year Treasury yield been climbing due to jitters about how much, and how quickly, the Federal Reserve will cut interest rates this year.
As of late-December, Wall Street was euphoric, certain that a soft landing was in the cards, pricing in a picture perfect 2024.
As we’ve pointed out here in the Digest, this resulted in a disconnect between the number of 2024 rate cuts projected by the latest Federal Reserve dot plot (three quarter-point cuts) and Wall Street forecasts (six or seven quarter-point cuts).
Wall Street has also been aggressive in its expectation for when these cuts will begin – the consensus has been March.
But over the last several weeks, we’ve received commentary from Federal Reserve members as well as some economic data that is making traders think twice.
Two days ago, Federal Reserve Governor Christopher Waller slightly spooked the market. While Waller did suggest the Fed could be cutting rates later this year, he added this nugget:
With economic activity and labor markets in good shape and inflation coming down gradually to 2%, I see no reason to move as quickly or cut as rapidly as in the past…
Meanwhile, in an interview on Bloomberg TV last week, Cleveland Fed President Loretta Mester said that March is probably too early for a rate cut.
On the data front, yesterday’s December retail sales came in at a 0.6% increase, hotter than the forecasted 0.4% rise.
Here’s CNBC:
The report comes amid speculation about how much strength the U.S. economy possessed heading into the new year, when growth is expected to slow.
However, a resilient consumer could signal more momentum and possibly give the Federal Reserve some caution about how to proceed on interest rates…
“The Fed was already hammering away on its ‘no rush to cut rates’ message, and today’s stronger-than-expected retail sales won’t give them any reason to change their tune,” said Chris Larkin, managing director of trading and investing for E-Trade from Morgan Stanley.
And this morning, we learned that weekly jobless claims came in at their lowest level since late-September.
Initial filings for unemployment insurance clocked in at 187,000. That’s 16,000 less than the prior week and below the estimate of 208,000.
Put it altogether, and bond traders are repricing the 10-year Treasury yield for a 2024 that’s perhaps not as picture perfect as before. And that keeps a lid on stock prices.
But while the S&P hasn’t been setting new highs, it hasn’t been correcting either
Though it might feel like the S&P has experienced a reasonable selloff over the last several weeks, it’s down less than 1% since its most recent high in late-December.
And let’s not forget that the S&P is just 1% below its all-time high set back in early 2022.
While this might make it seem that an S&P correction remains directly in front of us, there’s something interesting happening on the technical front.
Below, we look at the S&P along with its Relative Strength Index (RSI) and its MACD over the last three months. The RSI and MACD are two trading tools we often reference in the Digest to give us a better sense of a stock’s direction and momentum.
There are three things to notice in the chart.
First, up top, we have the S&P’s price, which has moved in a sideways channel since late-December.
Second and third, in the lower panes, we have the RSI and MACD. Both have been falling out of overbought conditions while the S&P has moved sideways.
Often this divergence between an asset’s price and its RSI and MACD levels is a prelude to lower prices to come. After all, the technical indicators are showing growing weakness. Think of a foundation crumbling beneath the floorboards of a house.
However, the longer that the S&P’s price remains stable while the RSI and MACD fall, it increases the odds of a different technical interpretation…
The RSI and MACD indicators are simply “reloading,” normalizing to a lower level that’s more conducive to supporting a fresh move higher in the S&P’s price.
An analogy is that of a spring compressing, getting ready for a new “pop.” If you’re an older investor like me, recall how you used to pull back the spring-loaded “ball-launcher” in an old-school pinball machine.
Today, it’s possible the RSI and MACD are pulling back, getting ready to help launch the S&P even higher.
To be clear, this doesn’t mean the S&P is guaranteed to avoid a correction in the months to come, but it could suggest we have another meaningful bullish leg higher before that.
Our hypergrowth expert Luke Lango just touched on all these variables in his market forecast
Let’s jump to Luke’s Daily Notes from Innovation Investor:
The stock market pushed lower this week as yields spiked on continued uncertainty about the pace and magnitude of Fed rate cuts in 2024.
While Tuesday’s price action was very ugly – about 90% of stocks dropped – we still maintain our thesis from late last week that stocks are in the final innings of their early 2024 selloff.
Treasury yields look overextended. Recent Fed commentary suggests the current magnitude of rate-cut pricing is appropriate. Inflationary pressures are easing once again. The CBOE Volatility Index (VIX) has spiked to nearly 15. Overly optimistic investor sentiment has cooled off. Extended technical conditions have normalized. And the upcoming earnings season should confirm the fundamental strength of the U.S. economy.
The stage looks set for stocks to start pushing higher very soon.
After all, we’re learning that consumer spending was very strong in the final three months of 2023. Business activity and CEO sentiment improved meaningfully as well. Against that backdrop, companies probably had a good fourth quarter.
It is therefore our belief that stocks bottom soon before charging higher in late January and throughout February on strong earnings.
Despite Luke’s bullishness, he doesn’t suggest investors go “all in” quite yet. He’s waiting until stocks confirm a technical breakout with an S&P push above 4800. We could be there by the time you’re reading this.
But circling back to the top of today’s Digest, keep your eye on the 10-year Treasury yield. The higher it goes, the tougher it will be for this market to return to sustained bullishness.
We’ll keep you updated.
Have a good evening,
Jeff Remsburg
