Headlines Said Flat. Equal Weight Said Otherwise,Yields Jump Above 5.20%, Oil Climbs, Gold Fades – Try the Pumpkin, Butternut Risotto

Things you need to know

• Equal Weight tells you what really happened.
• Bond yields surge again, Oil up, Gold down.
• Treasury buys $4.08 bil worth of long dated treasuries.
• Trump & Xi Xi? Yawn….
• Try the Pumpkin/Butternut Risotto

Good morning… and here we go again…. Yesterday was one of those days when the closing numbers did not tell the whole story. The Dow lost about 0.3%, the S&P finished flat, the Nasdaq gained 3 pts, so it was essentially flat too, the Russell lost 0.1%, the Transports gave up another 1.3% – pushing it further into a dark hole while the Mag 7 rallied by 0.7%. But here is the interesting point- the Equal Weight S&P lost 0.7% and that tells you more about what is going on – The headline said nothing happened. Underneath the sheets, plenty happened.

We saw weakness in a range of sectors – Industrials, financials, utilities, tech, consumer staples, consumer discretionary, basic materials, real estate, home builders, in the value trade, metals & miners, cybersecurity and aerospace & defense and that is reflected in how the Equal Weight S&P performed vs. the Market Weight S&P. It suggests more weakness than the headline index does.

The 10-year Treasury yield climbed above 5.20% – up more than 20 bps in 2 trading sessions – and that is something you need to pay attention to.

Why? Because bad things tend to happen when bond yields surge.

Higher yields tighten financial conditions. They raise the cost of capital, pressure equity valuations, hits housing and ultimately exposes the weak links in the financial system and that will ultimately force investors to reconsider what they are willing to pay for stocks.

Think about it – a 5.2% 10-year Treasury is going to cause some investors – especially the more risk-averse ones – to say: Why am I taking equity risk when I can get paid more than 5% to own a risk-free Treasury and sleep at night?

And THAT becomes the question for stocks. How many investors will make that decision? And if they do, what are buyers still willing to pay for equities?

That’s the equation everyone is trying to solve.

Now, Scotty tried to help the long end of the bond market yesterday with the expanded Treasury buyback program. Treasury offered to buy as much as $6 billion of longer-dated debt but ultimately accepted about $4.1 billion.

And here’s the key – $6 billion was a ceiling, not a promise. Buying less than the maximum doesn’t mean Treasury “failed” to support the market. It means they weren’t willing to accept every bond offered at every price. But bond traders were clearly hoping for more help, and the smaller purchase did little to stop yields from rising.

And that matters because Scotty can try to improve liquidity and calm trading conditions – but he cannot buy away the underlying concerns about inflation, government borrowing, government spending and the enormous supply of debt coming to market.

So why did yields jump again? Same argument.

It’s oil, its diesel, its geopolitical unrest, it’s overspending by the gov’t, it’s unease over inflation, it’s a FED that is backed into a corner and its anxiety building up around the mid-terms.

Yesterday oil rose by 2.8% to end the day at $94.80, Brent ended the day up 3.6% at $106.77…. Now we can discuss why, but why? We know the answer – And until there is some real resolution to the Iranian conflict, I would not expect oil to retreat substantially. We heard more talk yesterday about progress with Iran – but talk is not an agreement, and the oil market clearly isn’t convinced that a deal is imminent.

This morning oil is down about 1%, but WTI is still trading around $93.55. So don’t expect much relief just yet.

The VIX – also retreated a bit – and that suggests again that investors are not panicking. This morning it is unchanged at 15.58 and remains below all 3 trendlines in the complacent zone.

There was some decent economic news. Initial jobless claims fell to 197,000 for the week ended September 19, while August new-home sales surged by 6.4% vs. the expected increase of 1.3% which tells you that home buyers are active – but don’t forget – I made this point the other day – home builders have an advantage over Existing home sellers – they use incentives to help create demand – think ‘free upgrades’ like kitchen cabinets, flooring, trim, bathroom tiles etc.,

They can also ‘buy down the rate’ so that the buyer gets a lower mortgage payment – it is a sales incentive that can make the new home not only more attractive but more affordable without cutting the price. And finally, they can also cut the price to make it more attractive. So, while many are screaming about ‘affordability’ a stronger monthly sales number suggests that buyers are still finding opportunities.

And then we had the Trump–Xi Xi meeting and the extension of the U.S.–China trade truce until January 10th – and that gave investors and traders something else to consider.

But in the end, the meeting produced very little concrete news for markets yesterday or overnight into today. And I made that point in yesterday’s note – did anyone really think we were going to get something we could sink our teeth into? The truce got extended, everyone smiled for the cameras, they talked about trade, technology, AI and the broader relationship – but the big issues remain unresolved.

So, for now, it feels more like bluster than breakthrough. The January 10th extension simply kicks the can down the road and gives both sides another couple of months to negotiate. And that’s fine – because no escalation is certainly better than escalation – but let’s not confuse a pause in the fight with an actual deal.

Gold is trying to hold onto the trendline at $4,315 – but is having a hard time doing so after breaking down and through that level on Tuesday. This morning, gold is trading around $4,280, putting it firmly back into the $4,000/$4,315 trading range.

And with the market increasingly pricing in a more hawkish Fed and 2 additional rate hikes, I find it difficult to see gold making a sustained move higher from here – at least in the near term.

Remember – gold is an asset that pays you nothing to own it. So, when Treasury yields are north of 5% and investors can actually get paid to own ‘risk-free’ government paper, the opportunity cost of owning gold goes up. Add in the fact that higher U.S. rates tend to support a stronger dollar, and you’ve got another headwind for gold.

Now, that doesn’t mean gold can’t rally – geopolitical risk, inflation fears and concerns over government debt can all create demand for it. But if yields and the dollar continue to push higher, then gold is going to have a hard time fighting that battle.

Onto today…. The bond market finally caught its breath overnight. The 10-yr Treasury yield eased to 5.16%, and the 2-yr slipped to 4.89%. WTI & Brent have pulled back just a bit. Stocks in Asia were mixed, stocks in Europe are rising and US futures are higher. Dow futures are up 60, S&P’s up 8, Nasdaq up 100 and the Russell is up 4.

Eco data today includes Durable Goods, and U of Mich sentiment surveys and while they are important – I do not expect any of it to change the probability of coming rate hikes. Next week we get the Aug PCE report and that is the FED’s favored inflation gauge, and it is expected to be unchanged over July. If so, then that might change the narrative a bit, but we won’t know that until next Wednesday.

S&P closed at 7704 down 2 pts. Short term support is down at 7,630 – yesterday we tested 7,662 – and so for now – we remain in the 7,630/7,800 trading range…and for all of the angst – we are still closer to the all-time highs than not.

That being said – keep your eyes on the Dow Industrials and the Dow Transports. The Transports, as discussed, have already broken down and through their long-term trendline, while the Industrials are now threatening to test long-term support at 50,180 – about 2.3% below yesterday’s close.

Should the Industrials break that trendline as well, then the message from Dow Theory becomes increasingly difficult to ignore. The basic idea is simple: the Industrials make the stuff, and the Transports move the stuff – and in a healthy economy and a healthy bull market, the two should confirm one another.

Right now, the Transports are waving a caution flag. If the Industrials begin to confirm that weakness, then you’ve got a much more significant warning that the underlying market trend is deteriorating.

Now – to be clear – that does NOT mean that the market suddenly collapses or that a bear market begins the minute the Dow trades below 50,180. That’s not how Dow Theory works. But it would be another crack in the foundation – and with Treasury yields surging, oil above $90 and financial conditions tightening, it is a crack investors should not ignore.

Remember – bad things tend to happen when bond yields surge, because eventually higher rates expose the weak link causing investors t look around and to see where the pressure is building.

If you’d like to discuss your goals, evaluate the risk in your portfolio or simply get a second opinion, give me a call at 561-931-0190 or better yet – click on this link to connect. https://slatestone.com/contact-us/

I’m always happy to provide complimentary portfolio review and risk assessment.

Take good care,

Kp

[email protected]

Source: Bloomberg, CNBC, Reuters, Wall Street Journal

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