Is the equity correction over, or just taking a breather? – Index News
February 16, 2018 4:26 pm
Global equity indices have largely rebounded after their recent slide. The Dow Jones and the S&P 500 have already recovered more than half of their losses. While stock markets may well be headed for new highs, the sustained surge in US Treasury yields should give investors pause for thought, as fresh records in equities could be harder to achieve in a regime of rapidly rising yields.
Are we back to normal? Equity markets seem to have carved out a bottom and rebounded, posting consistent gains throughout the week so far. It appears that investors indeed viewed the correction as a new opportunity to buy at more favorable levels. What is most striking is that this recovery occurred even in the absence of any encouraging developments for equities from a fundamental perspective.
Let’s not forget that the initial trigger for the stock tumble was US Treasury yields moving higher, on concerns that higher inflation may be just around the corner, and amid worries that the US debt trajectory is becoming more unsustainable. Specifically, global equities began to correct lower after the yield on the 10-year Treasury crossed above 2.70%. The dynamics behind this are simple; as yields rise, bonds become more attractive to hold relative to stocks as they begin to offer a better and “safer” return, oftentimes leading investors to rebalance their bonds-to-equities exposure.
What has changed since last week? Well, data showed that US inflation was stronger than anticipated in January, pushing the yields on 10-year Treasuries as high as 2.94%, before retreating somewhat. While this was largely ignored by equity indices, which surged at the time, this may not remain the case for long if this pattern continues. Put differently, if Treasury yields continue to climb, for instance if the 10-year crosses above 3.0% and trends higher still, then stocks may well take notice.
Of course, higher yields do not automatically imply lower equities. Let’s recall that yields and stocks skyrocketed in tandem following the 2016 US election. Still, judging by the way markets have moved in recent days, a solid argument can be made that stocks won’t remain indifferent to sustained gains in yields. For equities to continue rallying in such an environment, they may require support from other factors that are strong enough to offset the downward pressure exerted by rising yields, such as a rosier outlook in corporate earnings.
Will US yields continue to climb? That will probably hinge on whether US inflation accelerates from here, and on whether investors’ concerns regarding the US debt outlook intensify. In terms of inflation, it could indeed pick up soon. Looking at the monthly core CPI prints (which compute the yearly rate), one can see a streak of disappointing figures from March 2017 onwards. At that time, the Fed attributed the softness to idiosyncratic factors that would fade over time. Once these weak monthly prints begin to drop out of the 12-month calculation during the spring and summer, the yearly CPI rates may well rise. Now as for US debt concerns, they are probably here to stay. For that to change, it would require either a marked increase in taxes or a sizeable cut in federal spending, neither of which is likely to happen anytime soon.
All in all, although things are looking increasingly better for stocks at the moment, one should not jump to the conclusion that the turmoil is over, and that it’s all plain sailing from here. Bond yields are firmly on the rise, and while that does not necessarily mean lower equities, it does make it harder for them to rally. A regime change seems to have occurred in recent weeks, and at the very least, this suggests that price action is likely to be much choppier moving forward.
While the probability of a bear market in stocks appears low still, lots of pundits expect major indices to retest their recent lows soon. In case they are right, the S&P 500 could move down for a test of the 2580 level, marked by the lows of February 8. If sellers manage to break that barrier, we could see downward extensions towards the latest lows at 2532.
That said though, even if such a decline occurs, it may prove to be short-lived, considering that the “buy the dip” mentality still appears to be in force. The S&P could rebound and gradually aim for a test of its highs. In this case, or if the index refuses to correct further and simply continues to move higher from current levels, then resistance may be met near the 2809 barrier, marked by the highs of January 16. A move above that hurdle could see scope for another test of the index’s all-time high, at 2872.
Global equity indices have largely rebounded after their recent slide. The Dow Jones and the S&P 500 have already recovered more than half of their losses. While stock markets may well be headed for new highs, the sustained surge in US Treasury yields should give investors pause for thought, as fresh records in equities could be harder to achieve in a regime of rapidly rising yields.
Are we back to normal? Equity markets seem to have carved out a bottom and rebounded, posting consistent gains throughout the week so far. It appears that investors indeed viewed the correction as a new opportunity to buy at more favorable levels. What is most striking is that this recovery occurred even in the absence of any encouraging developments for equities from a fundamental perspective.
Let’s not forget that the initial trigger for the stock tumble was US Treasury yields moving higher, on concerns that higher inflation may be just around the corner, and amid worries that the US debt trajectory is becoming more unsustainable. Specifically, global equities began to correct lower after the yield on the 10-year Treasury crossed above 2.70%. The dynamics behind this are simple; as yields rise, bonds become more attractive to hold relative to stocks as they begin to offer a better and “safer” return, oftentimes leading investors to rebalance their bonds-to-equities exposure.
What has changed since last week? Well, data showed that US inflation was stronger than anticipated in January, pushing the yields on 10-year Treasuries as high as 2.94%, before retreating somewhat. While this was largely ignored by equity indices, which surged at the time, this may not remain the case for long if this pattern continues. Put differently, if Treasury yields continue to climb, for instance if the 10-year crosses above 3.0% and trends higher still, then stocks may well take notice.
Of course, higher yields do not automatically imply lower equities. Let’s recall that yields and stocks skyrocketed in tandem following the 2016 US election. Still, judging by the way markets have moved in recent days, a solid argument can be made that stocks won’t remain indifferent to sustained gains in yields. For equities to continue rallying in such an environment, they may require support from other factors that are strong enough to offset the downward pressure exerted by rising yields, such as a rosier outlook in corporate earnings.
Will US yields continue to climb? That will probably hinge on whether US inflation accelerates from here, and on whether investors’ concerns regarding the US debt outlook intensify. In terms of inflation, it could indeed pick up soon. Looking at the monthly core CPI prints (which compute the yearly rate), one can see a streak of disappointing figures from March 2017 onwards. At that time, the Fed attributed the softness to idiosyncratic factors that would fade over time. Once these weak monthly prints begin to drop out of the 12-month calculation during the spring and summer, the yearly CPI rates may well rise. Now as for US debt concerns, they are probably here to stay. For that to change, it would require either a marked increase in taxes or a sizeable cut in federal spending, neither of which is likely to happen anytime soon.
All in all, although things are looking increasingly better for stocks at the moment, one should not jump to the conclusion that the turmoil is over, and that it’s all plain sailing from here. Bond yields are firmly on the rise, and while that does not necessarily mean lower equities, it does make it harder for them to rally. A regime change seems to have occurred in recent weeks, and at the very least, this suggests that price action is likely to be much choppier moving forward.
While the probability of a bear market in stocks appears low still, lots of pundits expect major indices to retest their recent lows soon. In case they are right, the S&P 500 could move down for a test of the 2580 level, marked by the lows of February 8. If sellers manage to break that barrier, we could see downward extensions towards the latest lows at 2532.
That said though, even if such a decline occurs, it may prove to be short-lived, considering that the “buy the dip” mentality still appears to be in force. The S&P could rebound and gradually aim for a test of its highs. In this case, or if the index refuses to correct further and simply continues to move higher from current levels, then resistance may be met near the 2809 barrier, marked by the highs of January 16. A move above that hurdle could see scope for another test of the index’s all-time high, at 2872.
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