The S&P500 bounced back lightly last week, rising by about 0.8% on moderate volume. Volatility slipped back down into ultra-complacent territory; the 30 day VIX for example, fell over 7% last week. Breadth, while still fairly strong, is showing signs of deterioration. The latest leg of the stock market’s advance is being led by a narrowing group of stocks. This is not what a strong bull market looks like.
US macro data continues to come in on the weak side. The ISM manufacturing index, a very important indicator, fell to 49 instead of increasing to 51. Anything under 50 means that US manufacturing is contracting; this is what we see during recessions. Also, this was the weakest reading since June 2009. Construction spending rose much less than expected, as did factory orders. ISM services, while still over 50, came in less than the consensus estimate. Initial jobless claims were slightly weaker than expected. Finally, the big report of the week was payrolls. While May was slightly better than expected, April and March were revised lower….largely offsetting the entire beat in May. The headline unemployment rate rose to 7.6%; it was supposed to stay steady at 7.5%. Average hourly earnings were expected to grow; instead, they stagnated (ie. showed zero growth). At the same time, the employment-to-population ratio and the labor force participation rate are both hovering near 30 year lows. The US labor market is suffering. It has been suffering for over 5 years, and most importantly, it’s not showing any signs of improving in a meaningful way.
Technically, the S&P downtrend, on the daily charts, is still in effect. The uptrend on the weekly resolution, however, has not been broken. Very soon, either the weekly uptrend will be broken, or the downtrend on the daily charts will reverse and rejoin the uptrend on the weekly charts.
Last week, we touched on the ominous sign that prices in fixed income markets are falling (ie. yields are rising) and that this if often a precursor, or leading indicator, of a drop in prices in equity markets.
This time, a closer look at the US Treasury market is warranted. At the end of last week, yields on the US 10 year Treasury shifted into positive territory for the first time in almost two years, as prices of Treasuries continued to sell off.
To the extent that buyers of (or investors in) mortgage debt need to hedge against rises in interest rates (because suddenly they will be more likely to be stuck with lower yields as homeowners reduce the amount of refinancing they’d otherwise conduct), these folks will need to sell more Treasuries to maintain their hedges. This in turn will drive down Treasury prices even more, which will cause rates to rise even further, creating the possibility of a Treasury selling vortex.
Why does this matter?
Because one of the strongest indicators of an imminent correction in stock prices is the falling of Treasury prices, leading to a rise in real yields, especially during conditions where the stock market is relatively over-valued and over-bullish.
This is exactly what is happening now…..for the first time in almost two years.