August 22nd, 2023
Hope Is Not A Plan
Bond yields are hurting the market right now and were partially responsible for the pullback earlier in the week. There’s also global concern that China’s faltering economy will drag down global growth. And with inflation not behaving, the Fed may need to change its mantra of “higher for longer” to “even higher for even longer” which would hurt equities. I’ll explain why treasury yields keep going higher and when we may see some relief.
The real issue is that short-term bonds are getting attractive again for “easy money” and investors are leaving unknown equity returns. Cash is pouring out of the equities market.
I’m looking at this level in the 30-year Treasury Bond Futures (117’27) as a crucial level that needs to hold. This level was the low set in October of 2022 and is a likely place where investors have their stops placed.
Should this line break (whether on a stop-collecting mission or otherwise), yields will push higher and that will help squeeze potential growth from the equities markets.
In other words, we need a bounce higher from this level to help equities continue their bullish run.
But here’s why we might not get that help. Yields keep rising because investors keep pushing out the date of expected Fed rate cuts. Again, the mantra of “higher for longer” is playing out, but as I mentioned earlier, rates may not be high enough.
In times of high inflation, the Fed wants to get real interest rates into restrictive territory so that economic growth and inflation slow. So what would be a restrictive rate? It depends on where the Fed feels the neutral rate should be.
The Fed’s goal has always been to get inflation back to around 2-3%, and the Fed funds rate is now at 5.375%. If the Fed feels a neutral rate is 0.5%, then being at 5.375% would mean we’re about 2 – 3% above the target goal. (5.375% – inflation goal of 3% – 0.5% neutral rate = 1.875%).
In theory, having interest rates 2 – 3% above a target goal would mean a serious problem for future growth. We should be in a period of restrictive growth right now based on these numbers. Some have said we’re already in a recession so maybe this will all start getting better soon.
But deflation is now stalling, above the 2-3% goal. Uh oh.
What if the Fed thinks the neutral rate needs to be higher? What if they think rates aren’t restrictive enough?
We don’t know what the Fed is thinking, but investors are increasingly pushing back the timetable for when they think the Fed will cut rates and that’s driving yields higher, which continues to suffocate equities.
Remember, Fed chair Powell is speaking at the end of the week and any hawkish comments will likely drive bonds lower, yields higher, and that could cause an exodus away from the riskier equities market.
If the bonds can hold, then we look to the stocks that will help drive the major indices higher.
Companies like Amazon (AMZN) need to hold their 50-day moving average (red line).
Apple needs to improve in order to help the rest of the market. A bearish crossover of the 20-day and 50-day moving averages is highlighting the weakness in the stock over the last month.
Maybe help from Microsoft (MSFT)?
That chart isn’t looking better. Uh oh.
As we get prepared for yet another Fed news-related event, I urge you to go back through previous articles of this newsletter – specifically the ones that John Hutchinson wrote during the last week of July where he mentioned several hedging strategies.
Whether you look to buy inverse ETFs (the kind that profits when the stocks in it go down), you buy a put or you buy an inverted put ladder, it’s time to think about hedging.
I still think we head higher to 445 in the S&P 500 ETF, the SPY. The 20-day, 50-day, and previous support/resistance areas converge at that level. Given that we broke lower through some key moving averages, it wouldn’t surprise me to see the market come back and re-test those lines. The question that we don’t know is if it will break higher or use that re-test to continue lower.
Don’t be mad if you hedge your portfolio and the market rips higher. Just picture what it would be like knowing your account was protected instead of you sitting around hoping the market doesn’t tank.
Hope is not a plan.
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