Hello traders
I hope you’ve all had a good week!
Bond markets remain the source of anxiety for equity investors with the 10 Year Treasury yield seeing a new high just below 1.60%. Federal Reserve Chairman Jerome Powell did surprisingly little to soothe the bond market in his widely watched WSJ interview midweek, which disappointed equity bulls and failed to calm their nerves. Beneath the surface, value continues to outperform growth and momentum strategies in particular, though the broader market has seen losses with the major indices giving back gains following a decent start to the year. March is barely underway, yet the market is down month-to-date despite a +2.5% rally on Monday.
So, is this cause for panic? We updated our Checklist Report for March for Trading Club members earlier this week. Whilst we cannot reveal all the scores here just yet, out of consideration for our premium members, I would like to share a couple of insights which you can of course learn more about in my weekly video analysis as a Trading Club member.
Let’s get right to the elephant in the room – 10-Year US Treasury bond yields. Although we do not have a dedicated Checklist for scoring the bond market directly, we do assess the Business Cycle and Market Risk with our other Checklists and can get a good feel for how things should be behaving in fixed income. We’ll look at these later, but for now I want to frame our analysis by looking at where we are on the chart. As you can see, we are almost at 1.60% today having been around 1% at New Year, and just 0.50% in August. This surge in the past 6 months has been driven by expectations for higher inflation, along with optimism around the economy reopening after COVID.
You’ll notice the Fibonacci retracements on there, which suggested to me that the break above 1.35% in yields (61.8% Fibonacci level) would lead to a break higher. Whilst it is still possible that the yield reverses at the 76% retracement level, we would need to see a correction imminently with the market currently against this level. A break above 1.60% could target a run up to 2%, and possibly even 2.35% in time.
Alas, this technical analysis paints a grim picture for equity investors who are concerned about rising yields at present. But we should also consider the fundamentals reflected in our ‘big picture’ Checklists. Here you can see our Business Cycle Checklist which shows a positive score, suggesting that the economy is improving and therefore perhaps warrants both higher equity prices, in addition to a normalisation in yields. Notably, the score is pretty much unchanged in recent months and is far from running hot, which challenges the idea of runaway inflation which is fuelling the surge in yields.
It may be that the anxiety amongst equity investors subsides if they can see beyond the recent surge in rates, accepting it as a ‘normalisation’ reflecting better economic conditions rather than a vigilante run on the stock market. Indeed, this is how Fed governors had been hoping that it would be seen, and there is always the potential for intervention to straighten out the bond market if the Central Bank perceives ‘disorderly’ trading a threat to asset price stability.
Further comfort can be taken from our Market Risk Checklist which also points positive this month and supports both higher bond yields and equity prices. For investors to be shunning both stocks and bonds simultaneously suggests that this is an overreaction – in terms of inflation expectations amongst bond traders, and yield sensitivity in the equity market.
The likelihood is that this bout of volatility may have caught many off guard, but has now seen investors adjust their portfolios and outlook for more balanced performance. Only time will tell how this plays out this month, but according to the fundamentals presented by our Checklist process it looks likely that this will all pass as the reality ends up being less scary than currently feared. Remember, investing is as much a study of mass psychology as it is the fundamental data.
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Have a great weekend,
James
Disclaimer: For educational purposes only. Even though we do our best to provide reliable data, you should not trade based on this information.
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