Amazingly, the parabolic move higher in the S&P500 continued last week. The index rose yet another 2.2%, on moderate volume. Contradicting this move higher in prices was the VIX index, which also moved higher—suggesting that at least some investors are beginning to worry about a stock market pullback.
Speaking of parabolic moves, the technical picture for the S&P continues to amaze everyone. While it’s still rare for an individual stock to shoot up in a parabolic fashion, it’s extremely rare to see the entire S&P500 do this—remember this index includes the largest 500 firms in the US. This is a very large index, representing trillions of dollars in market cap. It’s far from easy, or common, to have this index move upward in an almost vertical manner. And as already mentioned last week, such moves always—not usually, but always—correct by moving back down steeply…..eventually. That said, by definition, the greater the rate of ascent, the sooner parabola reaches its peak. So this reversal may not be that far off now.
In US macro news, the news continued to be mixed. The Chicago Fed National Activity Index beat expectations; initial jobless claims were better than predicted. And both durable goods and leading indicators beat their respective estimates. On the other hand, the Richmond Fed manufacturing index, the FHFA House Price Index, PMI composite flash, existing home sales, new home sales, and 4th quarter estimated GDP all missed their respective estimates. So as usual, there’s no economic boom to write about.
In an interesting development, the US Treasury market has made a very dramatic move over the last few months. First, the yield curve has flattened substantially, not because the long end of the curve has fallen in yield, but all because the short end has risen in yield. To many market and economic observers, a flattening — and more importantly, an inverted — yield curve is a precursor to an economic slowdown, or to be more precise, a recession. And while the curve has flattened substantially, it has not yet become perfectly flat. much less inverted. So the jury is still out as to whether or not the curve will actually invert…..and therefore signal an imminent recession.
Second, the 10 year yield has now crept up to about 2.7%. This is important because a huge percentage of consumer loans (eg. many home mortgages) are priced off the US 10 year T-note. And since the yield is now higher than it’s been in several years, there is a strong possibility that rising cost of consumer debt will negatively impact these other markets—such as housing and autos. Also, the rising yield in the ultra-safe Treasury market will begin to compete more seriously with the meager yields earned in the US stock markets. The yield on the entire S&P500 is only about 2%. So when the US 10 year yielded less than 2%, many investors refused to buy US Treasuries due to the meager yields; today at 2.7% and rising, this alternative suddenly becomes far more attractive. Will this rise in yields cause investors to sell stocks and buy Treasuries? Many hugely successful market analysts, from Bill Gross to Jeffrey Gundlach, think so.
Regardless of how bullish you may be about the US stock market, it doesn’t take a genius to figure out that the more risk-free Treasury rates rise, the more difficult it will be for US stock prices to rise. The biggest open question is at what level will rates create a tipping point? In other words, how much further will rates have to rise to cause stock owners to sell, and move their freed up cash into US Treasuries?