Starting gun
Key themes and stocks discussed today:
Consumer inflation in the US proved more stubborn than hoped in January, leading to a reassessment of bets on the timing of the Fed’s first interest rate cuts. Long-term Treasury yields surged, leading to a broad-based sell-off in stocks. The bond market continues to look vulnerable, with the interest rate cut narrative being pushed backwards into 2024.
The starting gun could have sounded on equities after a blistering rally from the October lows when the market has been up 14 out of 15 weeks of gains in a rally not seen since 1972. The good news is that support levels look quite defendable for the market. At the 4800 and 4600 key supports, the S&P500 would be down between 5% and 10%.
The Bank of America points to elevated bullishness and crowded trades in Mag 7 stocks and tech stocks. Conversely, bearishness abounds towards China/Hong Kong stocks, where the second most crowded trade is record shorts.
The US dollar index reasserted to the topside, but for how long can the currency extend to the topside? Before Congress is another $95 billion military aid package to Ukraine and Israel. The pace of fiscal spending and borrowing continues unabated.
The ASX200 closed slightly lower on Tuesday as earnings season gets into full swing. Some good news from local data offered support as consumer sentiment hit a 20-month high.
Stocks in Japan rallied, with sentiment bolstered by a positive update from a major tech firm. The benchmark index briefly crested the 38,000 level for the first time in 34 years.
UK wage data, combined with the American CPI data, was hotter than expected, leading to a risk-off day in UK stocks.
European shares were also pressured by the hot CPI data across the Atlantic, dragging the major benchmarks lower.
Notable charts and stock mentions include S&P500, US 2 and 10-year bond yields, Dollar Index, Nikkei, BoA Survey, Coca-Cola, Restaurant Brands International and TUI, Tokyo Election, BP, Sony, Temple & Webster, James Hardie and Challenger.
Good morning,
Wall Street equity benchmarks and bonds slid on Tuesday, hitting one-week lows following a CPI reading that printed hotter than consensus estimates. Inflation remains elevated with higher rent and healthcare costs. Yields surged across the curve with big jumps in the 10-year, which weighed on stocks and also pushed the US dollar higher. Investors did not like the fact that there have now been multiple upside surprises in inflation that have come from wages and a very tight labour market.
The markets also saw the high CPI print as pushing back on the rate cut narrative. Commodities came under pressure due to a stronger greenback with oil very much the outlier, surging 1.6%. The US Senate gave the green light on a $95 billion funding package for Ukraine and Israel, which will now go before Congress.
Pushing up the CPI were higher rent and healthcare costs. Headline January CPI index rose by 0.3%, which was 0.1% above consensus. The year-over-year advance in the headline CPI was lower by 0.3% to 3.1%, with the probability of a March 25 bp cut falling below 10% (from 76% a month ago). Meanwhile, core CPI jumped 0.4% month-over-month, which was the biggest spike in eight months.
But the sore point for markets is that consensus bets on mid-year rate cuts are being pushed out. Trader probability bets for a 25 bp cut in May dropped to 38.7% (from about 58% prior to the CPI), which weighed on the markets. It’s important to remember that the Federal Reserve targets the PCE deflator, not the CPI, but Tuesday was really all about investors looking for an excuse for markets to sell off following a blistering rally in recent months.
The Dow Jones fell -1.35%, the S&P 500 fell -1.37% to 4,953 while the Nasdaq Composite was down -1.8%. The Russell 2000 led the market on the downside falling -4%. Real estate and consumer discretionary led losses of the 11 major S&P 500 sector indexes. The prospects of higher yields in the bond market weighed down REITs. The VIX hit a two-week high, lifting 14% to 15.8.
Tuesday’s downside reaction on the S&P500 looks to be the “starting gun” for a corrective selloff, where stocks take a much-needed breather over the coming weeks following a blistering rally from the October lows. Wall Street has been on a tear, with the benchmark S&P500 gaining in fourteen out of the past 15 weeks, which is the first time this has happened since March 1972. The Dow is also trading at a record high, and on Monday, the Nasdaq briefly surpassed its record closing high from November 2021.
The first key support level is at 4800, being the breakout level at the historic highs, which would mark a 5% downside from the record high. Secondary support is prominent at 4600, which should prove formidable if any corrective selloff proves to be more extensive on the downside. For those still holding some cash, the coming months should provide an opportunity to deploy and invest.
Bond yields were reasserted to the top side with upside breakouts across the curve. The US 2yr and 10yr jumped 18 bps and 13 bps to 4.66% and 4.31%. I have been flagging the vulnerability and weak technical setup in the bond market for the past week, and we got a big reaction with Tuesday’s CPI likely to cause further potential weakness in the coming weeks. Commodities were weaker, with oil being the notable exception. WTI and Brent added 1% to $77.78 and $82.70. Gold was lower by 1.4%, silver lower by 3% and copper down by a more muted 0.5%.
The upside breakout in the 10-year yield (and other maturities) points to further systemic weakness coming in the bond market as investors react to the sticky inflation prints and, importantly, pushback on the rate cut narrative. The big technical question now for the 10-year yield is whether the twenty-year highs at 5.1% are retested? I don’t think that will prove to be the case. But at a minimum, I am expecting the yield on the 10s to remain higher for longer in an elevated range, with 4.5%, a prospective near-term target.
The US Senate passed a $95 billion Ukraine aid bill, which clears the way for Congress to vote in the coming weeks. The Democratic-led US Senate on Tuesday passed a long-sought $95 billion military aid package for Ukraine, Israel and Taiwan, although the outcome is uncertain given the Republican-controlled Congress. Ukraine sees the funding as crucial as it continues to repel Russian attacks and keep a battered economy going as the war enters the third year. Politics aside, the bill, if passed by Congress, will add to the growing US debt mountain.
The elevated CPI was one reason for the weakness in the US bond market. However, growing supply and the need for the market to absorb proliferate government spending is going to weigh over the longer term. The US 2-year yield broke out on the upside above 4.5%, hitting 4.64%. The scope is now raised for further upside extension towards the 4.8% in the coming weeks.
The US dollar index reasserted to the topside breaking through resistance in what was a predictable reaction to the CPI print and higher yields in the bond market. The upside dynamic could have been stronger. With the 104 level now assailed, the scope is raised for further upside extension, but resistance looks to be heavy above 106/107.
With stocks set to take a breather, it is always good to look at sentiment, where bullishness is elevated. Bank of America’s latest Global Fund Manager Survey, released on Tuesday, showed investors haven’t been this bullish on stocks in two years. There is, in particular and predictably, heightened exuberance around the Mag 7 tech names. Investor holdings of tech stocks have hit
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