Bond Yields Kiss 5.29% – How High Do They Go Before Something Breaks? – Try the Pastina Amore

Things you need to know

• Stocks continue to come under pressure.
• 10 yr bond yields push towards 5.3%.
• Oil plunges by 4%. Gold stabilizes after getting smoked.
• Lots of eco data – PCE will be the star of the show.
• Try the Pastina Amore

And here go again…. Stocks joined bonds and ended the day lower yesterday as investors continued to wrestle with the same question that has been hanging over this market for the past couple of weeks:

How high do rates or oil have to go before something breaks?

We’ll get back to that in a moment – but at the end of the day, here is what the scoreboard looked like. The Dow lost 0.25%, the S&P gave up 0.2%, the Nasdaq lost 0.1%, the Russell lost 0.35%, while the Transports bucked the trend and gained 0.35%. The Equal Weight S&P lost 0.1% and the Mag 7 gave up 0.15%.

So, yesterday was not a disaster by any stretch, but it was another down day that pushed stocks a bit lower. And if we step back and measure the “damage” from the recent highs, for the most part it remains fairly contained and still well within what I would consider a normal trading pattern.

The Dow is down 5.6% from its August high, the S&P is off just 2%, the Nasdaq is down 1.7%, the Russell is off 8.5%, the Equal Weight S&P is down 5.8%, while the Mag 7 has given up just 3.5%.

So, on the surface, you might say – what’s the big deal?

Well, this is where you have to look underneath the sheets, because the weakness is not evenly distributed – and that is what makes this market increasingly uncomfortable for investors.

While the major indexes remain relatively close to their highs, some very popular, widely owned individual names have taken a much bigger hit. JPM is down about 9% from its high, AMZN -14%, VZ -11%, IBM -33%, TSLA -29%, MU -15% and LLY about 9%.

Those are not insignificant moves. Yet at the very same time, you’ve got another group of popular names trading at or near their highs – AMD, CRWD, FTNT, NVDA, META and PANW.

And that is exactly why this market feels worse to some investors than the headline indexes suggest. The S&P may only be 2% off its high, but if you own some of these individual names, your experience has been very different.

And THAT is the point. This isn’t a market where everything is breaking down. It’s a market where the performance underneath the headline indexes has become increasingly uneven.

You can see it in the breadth. The market-cap-weighted S&P is only 2% off its high, while the Equal Weight S&P is down nearly 6%. That tells you that the average stock is taking more of a hit than the headline S&P would have you believe.

The Russell tells you something similar. It’s down 8.5% from its high as smaller companies – which tend to be more sensitive to financing costs and the economy – continue to feel the pressure of higher rates.

And then there are the Transports. They remain roughly 20% below their April high – putting the group in bear-market territory.

And we discussed why that matters. The Transports are economically sensitive. They move the goods, products and materials that make the economy work. So, when the broader market is hanging near its highs while the Transports are down 20%, you don’t ignore it.

It doesn’t mean the market is about to collapse – but it does scream caution and with the 10-year Treasury kissing 5.29%, some of this divergence does make sense. Higher rates don’t hit every company equally – and the longer yields remain elevated, the more we’re going to see the market separate the winners from the losers. That is the divergence investors need to pay attention to.

Which brings us to the bond market – yesterday the TLT lost 0.5% while the TLH gave back 0.3% leaving these names down 10.25% ytd and 9% ytd respectively.

The 10-yr kissed 5.29% yesterday before settling in at 5.25% while the 30-yr touched 5.6% – it’s highest level since 2002.And what that means is that investors are demanding more compensation to own long-term debt because they’re worried about persistent inflation, government spending, enormous Treasury issuance and now the explosion in corporate borrowing required to finance the AI infrastructure buildout.

Think about all of the money that needs to be raised to build data centers, power plants, transmission lines, semiconductors and everything else required to support AI. That capital has to come from somewhere and those investors want to get paid.

And so, the weakness we’re seeing underneath the headline indexes makes perfect sense. And the longer rates remain elevated, the more pressure we will see on the parts of the market that are most sensitive to financing costs and economic growth.

And THAT remains at least part of the story.

Now, the other part is oil and what is even more interesting is that oil actually fell yesterday – losing 4% — News that Trump is releasing more oil from the SPR (Strategic Petroleum Reserve) and that the Saudis are increasing shipments through the repaired East-West pipeline responsible for that move.

All of that helped push prices lower. And that is good news. But the issue remains…Brent at $102 is still elevated. WTI below $90 is good, but global energy prices remain high enough that we can’t simply dismiss the inflationary implications.

Remember the chain: Energy higher → inflation expectations higher → Fed expectations higher → Treasury yields higher → pressure on stocks.

So, while yesterday’s decline in crude was welcome, one day doesn’t solve the problem. We need to see Brent, WTI and Diesel break decisively below current levels for this to matter, so as long as the conflict in the Middle East remains unresolved, that is not happening. Investors will continue to price in a geopolitical risk premium. Period.

And that brings us right back to the Fed – because if energy remains elevated and inflation remains sticky, the Fed can’t simply look the other way.

Yesterday – NY Fed President Johnny Williams told us that maybe only one more rate hike this year may be needed and that there is no urgency to even do that. While Mikey Barr reiterated that more rate hikes are needed to bring inflation under control. So, it’s this game of cat and mouse – exactly what Kevy Warsh is trying to prevent…This morning – the chances of an October hike are now only 47% – down from 81% just days ago while the market is pricing in an 84% chance of a December hike.

And here’s where the story gets even more complicated – because while inflation, oil and the bond market are telling the Fed to remain vigilant, yesterday’s economic data suggested that higher rates may already be starting to bite.

U.S. job openings fell to a five-month low. Layoffs remain relatively subdued — which is good — but employers appear to be becoming more cautious about adding new workers. Companies aren’t necessarily firing everybody. But they’re not aggressively hiring either.

And then we got the consumer-confidence number it fell to its lowest level since 2014. That’s not insignificant. Persistent inflation, higher borrowing costs, elevated energy prices and the cumulative effect of higher prices are clearly weighing on how consumers feel.

But remember – sentiment and spending are not the same thing. Consumers can tell you they’re miserable and then go out and spend money anyway. We’ve seen that movie before. So, the question isn’t simply whether consumers feel bad. The question is: Does that weakness in confidence finally translate into weaker consumer spending?

And THAT is what upcoming earnings season will tell us. Because the consumer still represents about 2/3rds of the U.S. economy. If consumers begin pulling back at the same time borrowing costs are rising, that changes the economic conversation very quickly. And it puts the Fed in an increasingly uncomfortable position: Inflation says tighten. The bond market says tighten.

But parts of the economy may be starting to say: Careful big boy….and so the clock ticks.

And today is a BIG day for economic data – and considering everything we just discussed about inflation, the Fed and the bond market, the timing couldn’t be more important.

We get Mortgage Applications, ADP Employment, Personal Income and Personal Spending, along with the final read on second-quarter GDP.

Personal Income is expected to rise by about 0.4%, while Personal Spending is expected to jump by roughly 0.8% – up sharply from the 0.2% increase last month. ADP is expected to show private employers added about 68k jobs in September, up from 38k last month.

But the BIG one comes at 8:30 – August PCE – the Fed’s preferred inflation gauge. Headline PCE is expected to rise somewhere between 0.3% and 0.4% m/m, depending on the survey, with the y/y rate expected to hold around 3.7%. Core PCE – EX food and energy – is expected to rise 0.3% m/m and 3.3% y/y.

And THAT is the number the bond market is going to react to. If PCE comes in around expectations – or better yet, a little cooler – then I would expect yields to settle down and stocks to breathe a sigh of relief. But if PCE comes in hotter than expected? Then look out. Because with the 10-year already sitting around 5.25%, a hot inflation print would reinforce the idea that the Fed still has more work to do – and could send yields right back toward yesterday’s 5.29% high and put renewed pressure on stocks, especially the rate-sensitive names we’ve been talking about.

And remember – today’s numbers are just the opening act.

Friday, we get September Non-Farm Payrolls. Current estimates are centered around roughly 100k new jobs, and THAT report – along with wages and unemployment – will give us another critical piece of the puzzle ahead of the Fed’s October meeting.

So, between PCE today and NFP on Friday, we’re about to find out whether the economic data gives the bond market a reason to calm down – or another reason to push yields higher.

Now, we haven’t discussed gold yet…well, it got smoked on Monday and then tried to stabilize yesterday.

Monday’s move deserves some explanation because, at first glance, it seemed completely counterintuitive. Gold fell nearly 4%, trading down to $4,111 at one point.

Let’s pull that apart…. We’ve got a war in the middle east causing all kinds of geopolitical unrest. We’ve got concerns surrounding the supply of oil thru the Strait sending energy prices soaring.

Normally that setup screams: BUY GOLD! Yet on Monday – it got sold. Why? Because investors weren’t looking at the geopolitical situation as a safe-haven story, but rather an inflation story.

Oil higher → inflation fears higher → expectations for additional Fed tightening higher → Treasury yields higher → dollar higher → gold gets smoked.

Remember — gold doesn’t pay you anything to own it. So, when the 10-year Treasury is suddenly offering you more than 5.25%, the opportunity cost of owning a non-yielding asset (gold) becomes much greater.

And we haven’t even discussed the stronger dollar. A stronger dollar creates another headwind for gold because dollar-denominated commodities become more expensive for foreign buyers.

Then the technicals kicked in. Once gold broke down and thru the trendline at $4,287, the momo guys and the algo’s jumped on board, adding to the selling pressure. And suddenly you’ve got a nearly 4% move.

And Here’s What I Find Most Interesting…After all of this, volatility remains remarkably contained. Think about it – The 10-year is around 5.25%. The 30-year is near 5.60%, its highest level since 2002. Brent is above $100 while WTI is below $90. The dollar is strengthening. We’ve got an ongoing conflict involving Iran. The Fed is still talking about additional rate hikes. Job openings have fallen to a five-month low. Consumer confidence is at its lowest level since 2014. Gold just suffered a nearly 4% one-day beating.

And yet the VIX remains remarkably calm at 15.90. Maybe investors are right – there is nothing to worry about…. Maybe oil retreats, maybe inflation cools, Maybe Treasury yields finally stabilize, maybe consumers keep spending, maybe earnings continue to support valuations, and maybe this market continues to absorb every punch thrown at it.

Maybe.

But remember – complacency becomes an issue when investors begin pricing in almost NO possibility of a negative surprise.

European markets are higher this morning. Spain up 1% while France is up 0.2% – everyone else is in between.

US futures are higher as well. Dow + 200 pts, the S&P’s +17 pts, the Nasdaq is +50 pts, while the Russel is +8.

The S&P closed at 7,670 — down 12 points — We remain in the 7645/7800 (trendline support/all-time highs) trading range and as I noted – we are still much closer to the highs than not and considering everything going on – I find that remarkable. Should we break 7645 – then intermediate support can be found at 7555 – still only 3% off the high….

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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