The 10-year treasury yield ended with a weekly shooting star last week, briefly rising above two percent. Only about two and a half months ago, rates were 1.34 percent. The 10-year may be ready to unwind at least some of the overbought condition it is in. This may not necessarily help stocks as the major equity indices just got rejected at important resistance.
The 10-year treasury yield last week was up 13 basis points at Friday’s high but reversed to close up only two basis points. As a result, a shooting star formed on the weekly at an important juncture.
For the first time since July 2019, rates crossed two percent both Thursday and Friday last week, with Friday reversing hard but not before ticking 2.06 percent, closing the week at 1.95 percent. As recently as December 2, the 10-year yielded 1.34 percent, so has come a long way.
Going back to December 2008, the two handle has proven to be a place where both bulls and bears seemed willing to lock horns with each other. This can prove to be an important psychological hurdle. This also approximates the back-test of a broken rising trend line from August 2020 (Chart 1).
Another trend line from that low extends to mid-1.40s, which the 10-year broke out of last December, followed by the takeout of 1.77 percent in January. The latter could be in play in the weeks ahead, if nothing else just to test bond bears’ (on price) mettle.
Should rates head lower, it is too soon to say if this will end up helping tech. Of late, tech stocks have weakened when rates rise, although the Nasdaq 100 sold off hard last Friday and was unable to reverse higher even as the 10-year reversed lower mid-day.
The relationship between rates and tech is obviously not that precise but in recent months stocks have shown a tendency to drop more versus their peers when rates rise. This then follows that the sector should respond favorably to lower rates, but it is not that simple.
Between the November 22 (last year) high and the January 24 low, the Nasdaq 100 collapsed 18.1 percent, worse than the S&P 500’s 12.4 percent drop between last month’s high and low. A 50-percent retracement of this decline lies at 15245. This was just about tested on February 2 when the Nasdaq 100 tagged 15196 before sellers showed up.
Following minor selling after that, the tech-heavy index (14254) tried to rally last week, tagging 15058 on Wednesday and 15037 on Thursday, but the 200-day (15054) came in the way (Chart 2); Thursday, it shed 2.3 percent and Friday 3.1 percent.
As things stand, the January 24 hammer low of 13725 has gained in significance. If this holds, there is room for the weekly to rally. For now, the daily seems to want to go lower.
Not only did the Nasdaq 100 sell off more than the S&P 500 but it also fell behind in retracing that decline.
The S&P 500 peaked on January 4 at 4819 and bottomed on the 24th at 4223. A 61.8-percent Fibonacci retracement of that decline lies at 4591 (Chart 3). On the 2nd (this month), the large cap index rallied to close at 4589 (4595 intraday) before weakening. This level was tested again last Wednesday as the index ticked 4590 intraday, followed by Thursday’s 4589. To boot, the 50-day at 4609 lies in the vicinity.
The bulls could no longer hold the fort. In the last two sessions last week, the S&P 500 (4419) lost 1.8 percent and 1.9 percent respectively. The 200-day (4452) has been breached slightly.
Right here and now, odds favor continued downward pressure.
Interestingly, in a larger scheme of things, the message coming out of small-caps is anything but encouraging. By nature, these companies have larger exposure to the domestic economy than their larger-cap brethren. So, arguably, how they perform can be taken as markets’ way of saying which way the US economy is headed.
Since last March, the Russell 2000 (2030) had been rangebound between 2350s and 2080s, and between 2280s and 2150s within this box. On Nov 3, it broke out but was quickly followed by a failed retest on the 19th (that month). On January 19, it broke down, dropping out of the rectangle. The subsequent decline took the small-cap index all the way down to 1901, which was ticked on the 28th.
A rally off of that low stopped at 2105 last Thursday, with the week closing at 2030. It so happens the Russell 2000 retraced 38.2 percent of its November 2021 high (2459) and the January 2022 low (1901) – for a drop of 22.7 percent – before sellers appeared (Chart 4). This was also a back-test of the broken box, and it was strongly rejected.
The daily has now been pushed into overbought territory. At this point, a test of 1900, which drew bids both this January and last, looks more likely. It is a must-save.
In the weeks ahead, inflation likely continues to drive investor sentiment, as the pace – and magnitude – of policy tightening will be decided by this.
After last Thursday’s CPI (consumer price index) report, another major report is not due out until Feb 25, when the PCE (personal consumption expenditures) price index for January comes out. Core PCE, in fact, is the Fed’s favorite. Until then, markets in all probability will be on pins and needles.
As a matter of fact, February’s CPI is scheduled for March 10. The next FOMC meeting is on March 15-16. The Fed thus has two important reports before it assembles in March. January’s CPI report last Thursday caused quite a stir. Headline and core CPI surged 7.5 percent and six percent year-over-year. This was the steepest price increase since February and August 1982 respectively (Chart 5). Post-CPI report, futures traders are giving a slight edge to a 50-basis-point hike in March. But, unless they decide to meet intra-meeting, the March gathering is still a month away, which also means plenty of uncertainty.
In a time like this, as important resistance has held on major equity indices, it does not take long for selling to feed on itself. In all the three indices above, as well as others, the daily is extended. This creates room for downside pressure.
Concurrently, our proprietary Hedgopia Risk Reward Index has just been pushed into the red zone (Chart 6). No system is perfect, but, if past is prelude, it has paid to take caution when the index is as overbought as it is currently.
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