After Thursday’s Pounding, Bond Yields Hold Key To Market As Weekend Nears

After yesterday’s heart-wrenching finish, the question is whether things can recover a bit before the weekend. It looks like the bleeding has slowed, but a lot depends on what happens in the bond market.

All eyes remain on the 10-year Treasury yield, which rose as high as 1.6% yesterday after starting the year near 0.9%. The rapid rise fuelled concerns about possible inflation and economic overheating. Also, the 10-year yield is now roughly equal to the S&P 500 dividend yield, meaning Treasuries could pose more competition to stocks.

The yield ticked down a little to 1.47% early Friday, way below yesterday’s peak but still much higher than a week ago when it was under 1.3%. The slip in yields may weigh on the Financial sector today, but we’ll see if Tech can come back. The NASDAQ Composite, which is heavily weighted toward Tech, dropped 3.5% yesterday.

It’s Friday, which might feel like a relief after the week we’ve had but also could clarify where things stand on Wall Street. During the first wave of the pandemic, when fear stalked the markets, you often saw big drops on Friday because people were worried about holding onto long positions ahead of a two-day break. How this session develops, and how futures trading goes on Sunday night, might offer some clues about investor sentiment. Will people sell into the weekend, or will they feel confident jumping back in?

h2 Seeking Clues in VIX, PCE, Technical Support Levels/h2

It would be pretty impressive if we bounce back today, but that could depend on more than just yields. For instance, the CBOE Volatility Index had a big day yesterday, finishing above 28. That was up about 34%, a pretty big move for one day. If it keeps rising and goes above 30, that might put people in a more cautious mood. The 30 level is key. VIX slipped just slightly early Friday but remains above the 28 level, well above where it started the week near 21.

Another thing to monitor is whether either the COMP or the S&P 500 Index can climb above some levels that got breached yesterday. Technically, some pretty important levels got taken out Thursday, with the COMP falling below its 50-day moving average and the SPX falling below its 20-day moving average. The 50-day of the SPX is near 3805, while a possible support level to watch for the COMP is 13,000. It’s tested that level several times recently.

Then there’s inflation. One thing that’s clipped the market and raised Treasury yields lately is fear that the economy may be overheating. This morning’s Personal Consumption Expenditure (PCE) prices report for January showed a 0.3% rise in both core and headline PCE prices, neither of which is likely to strike fear in anyone’s hearts. Household income jumped 10% in January and personal spending grew 2.4%, more evidence of economic recovery but also something that may reinforce concerns about overheating.

If you’re one of those who’s concerned, consider this: The SPX is down about 2% for the week, but remains just 3% away from all-time highs. Let’s keep things in perspective: Overall, the market hasn’t completely fallen out of bed. Stocks are still up more than 70% from the pandemic lows posted last March. While it may not be a good time to go “all in,” so to speak, there’s also no reason to panic.

Over the last week, leading sectors are Energy, Financials, and Industrials, exactly the ones you’d expect to do well in an improving economy. It’s been a tough week for Tech, as you might already know, and Consumer Discretionary is another laggard. That’s mainly due to the plunge in Tesla (NASDAQ:TSLA) shares.

Whether the market can engineer a quick recovery and get back on its feet depends partly on the path of the 10-year yield, but also on whether last year’s leading stocks like Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), and TSLA can stop retreating. AAPL is down 17% from its highs, and TSLA is off 24% from its peak. Having said that, it’s not unhealthy to see some other sectors—especially Financials—show some life.

h2 Data Impressive So Far This Week/h2

Earlier this week, economic data looked more than OK. It looked pretty amazing. Durable goods and orders both came in way above expectations, and so did new home sales. Consumer confidence rose in February, and initial unemployment claims fell last week (though some of the decline may have reflected people not being able to file after the storm in Texas).

All this now arguably gets filed in the “good news is bad news” department, because it helps contribute to higher rates and more worry about overheating. Today’s expected stimulus vote in the House of Representatives is another possible touchpoint.

Today is the last trading day of the month, which might be meaningful in some respects. It’s not like the end of a quarter in terms of so-called “position squaring,” but there is some significance and it could possibly mean a little buying interest after the market’s big dip.

If there’s buying interest, we’ll see if it shows up in the battered and bruised Tech sector. Many stocks there got smoked yesterday, particularly semiconductors. The rising Treasury yield environment appears to be having a more substantial impact on Tech stocks, many of which trade at high valuations. Those valuations seemed reasonable to many analysts when yields were below 1%, but maybe not so great with yields at 1.5%. Remember, Tech got a big pushback in late 2018 when the 10-year yield climbed above 3%.

Despite the yield worries, investors don’t appear to have much concern about a rate rise this year. Chances fell to just 2% in the Fed funds futures market by late Thursday, down from above 10% earlier this week. It looks like Fed Chairman Jerome Powell’s testimony to Congress this week, where he talked about the economy being a long way from normal, might have convinced investors the Fed doesn’t plan to act anytime soon. The question is whether they might take a smaller measure, like cutting back on bond purchases. Honestly, that doesn’t seem likely, either.

Sectors Bet On Inflation: The big story this week has been the 10-year Treasury yield climbing to new one-year highs above 1.5% from 0.9% at the start of 2021. This partly reflects hope for improved economic performance with a fiscal stimulus possibly ahead, but also reflects worries about inflation. So one question for investors is how to position themselves for these potential developments.

Financials and Energy have been leaders, and both are typically sectors that benefit from inflation. That said, the Fed continues to sound unworried. “Inflation dynamics do change over time, but they don’t change on a dime,” Powell told Congress this week. “We don’t really see how a burst of fiscal support or spending that doesn’t last for many years would actually change those inflation dynamics.”

If Powell’s right, maybe betting on inflation-driven sectors being helped long-term by the stimulus isn’t a slam dunk. Also, avoiding sectors like Utilities and Consumer Staples that traditionally perform poorly in an inflationary environment isn’t necessarily a “buy and hold” strategy either.

Pieces Of A Puzzle: There’s a reason stocks, bonds—and all asset classes really—don’t move in a straight line. News happens, and markets respond in real time, ebbing and flowing in constant search of equilibrium. That’s nothing new. But this market has been a challenge in that the pandemic ravaged the current economy, but the markets arguably began pricing in not only a post-pandemic economic surge, but also had to absorb several rounds of fiscal and monetary stimulus . Meanwhile, the Fed has offered a number of reassurances to the market that it would continue to put the pedal to the metal in terms of ultra-low interest rates, regardless of any potential inflationary headwinds.

But what if the bond market develops its own ideas about the equilibrium level of interest rates? And what about segments of the stock market that may have priced in lower rates than the bond market? If Thursday’s selloff is a guide, that question is being asked these days.

Not Jumping On Bandwagon: Bitcoin keeps flirting with $50,000, helped by corporations like Tesla (TSLA) beginning to embrace the cryptocurrency. So with that in mind, it was surprising to see a story that went a little under the radar earlier this week: Mastercard (NYSE:MA) came out and said bitcoin won’t work for its plans because it’s too volatile.

“Bitcoin doesn’t behave like a payment instrument,” Ann Cairns, executive vice chair at MA told the Future of Money conference, according to MarketWatch. “It’s too volatile and it takes too long to transact. So if you and I went for a cup of coffee, and you know, I decided to pay with bitcoin, our coffee might cost me, I don’t know, 40% more by the time it was served—and it takes 10 minutes to actually settle the transaction.”

That’s a bit exaggerated, of course, and it doesn’t mean MA won’t allow cryptocurrencies into its network. It said it would a couple weeks ago. Just not bitcoin. As much as we hear about other companies jumping on the bitcoin bandwagon, it’s interesting to hear another side to the story.

Disclaimer: TD Ameritrade (NASDAQ:AMTD)® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

Written By: TD Ameritrade