Rising rates are the kryptonite of the stock market

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Famed newsletter writer and timekeeper Joe Granville coined many famous witticisms in his day, many of which are still used today. His most famous, “The evidence is obviously false,” ultimately has become the unofficial mantra of market contrarians everywhere. “As soon as you think youI have the key to the purse, they change the lock,is another well-known granville-ism.

While most of GranvilleBromides was concise and (for the most part) precise, at least one of his oft-repeated observations missed the mark. At an investment conference many years ago, he once posed the following rhetorical question: “What do interest rates have to do with the stock market?“Naaah thing!‘ was his sardonic reply.

As for the latecomer, great timekeeper of the market, I have to emphatically disagree. Interest rates are in fact intimately linked to the stock market and can have an outsized impact on the direction of stock prices. put onyou do not believe me? Then look at what’s happened to the stock market this year since bond yields started to soar.

A trip down memory lane in recent history should suffice to further prove this proposition. In the months leading up to the 20% stock market correction at the end of 2018, yields across all Treasury bond maturities rose steadily, with the 10-year Treasury Yield Index (TNX) rising from 2.4% to more than 3.2. % (up 33%) over a 10-month period.

Meanwhile, the number of 52-week lows on both the NYSE and Nasdaq hit unusually high levels for several months, led primarily by bond funds and other income securities. More than one market analyst dismissed the worrying rise to new 52-week lows at the time, saying bond funds should be ignored as they are not‘t really stocks. Therefore, there was nothing to worry about, they said.

They were very wrong. Ultimately, the pressure from rising rates, coupled with the Federal Reserve’s tightening monetary policy, was too much for the stock market as a whole to bear. The shares fell in a cascade from October 2018 and fell steadily until late December before finally bottoming out.

Fast forward to 2022. This time around, the 10-year yield has risen from 1.2% to over 3% in just nine months, an astonishing 150% increase, creating huge downsides. currents and headwinds for actions. Today, as in 2018, fresh 52-week lows on both major exchanges remain extremely high (well in the triple digits on most days), with rate-sensitive bond funds accounting for the bulk of the selling pressure .

Already wesaw a formal “correction(defined as a decline of 10% or more) in the S&P 500 and a bear market (down more than 20%) in the Nasdaq Composite. Both events could easily be attributed to the negative impact of the rate hike.

While the S&P 500 and Nasdaq have repeatedly tried to bottom out recently, rate-related weakness has once again crept into the equity market in a growing number of sectors. The Nasdaq Composite’s 5% pullback at the time of this writing on May 5, led by several big growth-focused names, once again underscored the negative impact of rising rates.

Meanwhile, the latest push to new highs in the 10-year yield index reflects growing concern among many investors that a bear market could soon set in if rates continue on their current path.

CBOE 10-Year Treasury Yield Index

BigCharts

One of the main reasons why rising rates tend to be destructive for stock prices is due to competition for investment funds from income-oriented participants. With US government bond yields currently well above the average yield of the Dow 30 stock index, money is moving away from equities and into higher-yielding bonds.

10-year bond against yield of the Dow 30.

WSJ, author table

Historically, whenever the spread between 10-year bond yields and the Dow 30 has widened in favor of bonds, equities have tended to underperform. Hence my assertion that rising rates is the stock marketit is “kryptonite.

high performance business, or “waste,Bonds are also in a precarious state as prices have consistently fallen while yields rise. JNK’s decline has been consistent for several months (as it was before the 2018 crash).If the chart below is any indication, equity investors can expect volatility levels above the normal in the coming months.

SPDR Bloomberg High Yield Bond ETF

BigCharts

There is however a chance that stocks could dodge the interest rate “bomb“if the upward trend in rates reverses quickly in the near term. both business and treasury) could happen in the coming weeks.

One of them is the McClellan oscillator for the high yield bond market which just hit its highest (i.e. most oversold) level since the March 2020 crash. (This indicator examines the difference between the short-term and medium-term moving averages of the net number of junk bonds advancing on a daily basis). As a SentimentTrader‘s Jason Goepfert recently observed, it just hit +75 for only the third distinct time in the past 5 years last month, as seen in the following chart.

McClellan oscillator for high yield bonds.

Sentiment Trader

And though that’s not enoughThis does not guarantee that a reversal in bond yields will occur, it gives bulls a chance to regain control of the short-term trend based on the apparent build-up of short-term interest in the bond market to high yield. In other words, it would probably beIt doesn’t take much to trigger a rally in bond prices (and a corresponding decline in yields).

For now, however, the main evidence argues for a defensive stance for stock market participants and a delay in making major commitments in riskier areas of the stock market. And until the upward trend in bond yields reverses, the stock market will face a major headwind.

About Meredith Campagna

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