And Here Comes the Bounce!

After falling for several weeks in a row, the S&P500 roared back with a 3.8% bounce last week……on the heels of a surprise win by Donald Trump in the US presidential election. Volume was moderate, and volatility—while spiking during the actual election night—dropped way back down by the end of the week. This drop goes hand in hand with the large bounce in US equity prices.

In US economic news, the wholesale trade missed expectations. Initial jobless claims came in a bit better than expected, and consumer sentiment also beat expectations. So not much in the way of economic reports. Instead, the dominant story of the week was the Donald Trump victory and the impact on financial markets. While the initial reaction to US equities was negative (the futures markets plunged in the hours after the election results became clear), stocks not only recoupled all initial losses, but the went on to roar higher. In fact, by the end of the week, the Dow Jones Industrial average set a new high. But that was pretty much it for asset classes doing well. Almost all other major asset classes dropped, and in many cases, dropped hard. Commodities (oil for example) plunged. US corporate bond prices (especially high yield) dropped notably. US Treasury prices plunged….sending yields up to 2016 highs. Emerging market bonds also plunged. So just about the only asset class that did well….so far….was US stocks.

And technically, this bounce in US equity prices was completely not unexpected. Once again, as noted here only last week:

But more importantly—what’s next? Well the most likely reaction to almost ten straight days of consecutive selling (a record that dates back to 1980!), is some sort of short-term bounce. Precisely because of the long streak of losing days, a bounce becomes a much more likely outcome in the next several days. Why? Because technically, the S&P is oversold on the daily charts, and a reversal would be perfectly normal to predict as the expected outcome over not only the next several days, but even over the next week or two.

And this is exactly what happened.

The main concern about the duration of this bounce is the rising US Treasury yields. As of last Friday, the yield on the US 10 year note reached 2.15%…..which is just a bit higher than the yield on the S&P500 itself. This means that many investors who were looking to the large cap US stock market for a reasonably safe return will now suddenly have reservations—why should they earn a lower dividend in riskier US stocks than they can earn in less risky US Treasuries?  Good question. And history supports this concern—almost all large drops in US stock markets were preceded by rising interest rates. In other words, when all other major asset classes are suffering, and US interest rates are rising substantially, it’s going to be very difficult for US stock prices not only to continue rising much further, but to even hold the gains they’ve recently achieved.

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