Stocks, Bonds Switch Places In Turnaround, But COVID Concerns Continue

 | Jul 09, 2021 10:21AM ET

Like a game of seesaw, the falling bond market appeared to give stocks a boost early Friday. Yesterday it was stocks at the bottom and bonds high up.

For now, anyway, stocks are climbing along with Treasury yields, which rise as bonds fall. The 10-year yield bounced back from yesterday’s five-month lows and recently traded above 1.3% again, which may be easing some of the economic slowdown concerns that dominated Thursday’s trading.

It’s important not to get too carried away by this early rally, because things still could easily go back the other way in a market where caution seems to be attracting many investors to fixed income over stocks. Today we’ll watch rates and see if that can help the financial sector, which might also help the S&P 500 Index and the Russell 2000 Index. Along with yields, crude is also popping up a bit this morning.

When it comes right down to it, worries about the Delta variant of COVID and possible slowdown of reopening probably explain a lot of what’s happened the last day or two. People are worried that international economies like Japan aren’t reopening as fast as anticipated, leading to thoughts that overseas central banks won’t be super quick to taper stimulus programs. News that some countries like Australia are tightening COVID protocols could spook the market if it continues.

The Fed doesn’t operate in a vacuum, and the U.S. isn’t immune to the Delta variant even though so far vaccinations here have outpaced many other countries. If the European Central Bank or the Bank of Japan have to delay tapering, that could influence how quickly the Fed handles it. There was a lot of talk on Wall Street on Thursday that the Aug. 26-28 Jackson Hole conference wouldn’t be when the Fed starts laying out a tapering schedule, and that sometime in September or beyond looks more likely. We’ll have to wait and see.

Another thing that might be in the back of peoples’ minds is a bit of a slowdown in recent Chinese economic data. Inflation data from China released earlier today showed a small retreat from the previous month for producer prices. It was still high, but the slight dip raised more concerns about growth there. Consumer prices in China were up just 1.1% from a year ago, suggesting domestic consumer sentiment remains sluggish, The Wall Street Journal reported.

h2 Technical Support Holds Up For SPX - So Far/h2

On the plus side, an early drop in the S&P 500 Index to below 4300 on Thursday didn’t last, with the SPX quickly clawing back above 4300, a key psychological support point. If things do start to slide more from here, one possible support level under the market is at the 50-day moving average for the SPX. That level now is around 4217. To this point in 2021, the 50-day has been tested many times and the market has bounced back regularly.

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While 4300 held, it would also be supportive from a technical perspective if the SPX could hold an area around 4340 today. That’s near the July 6 close and might be one to watch. It would be a great sign for the bulls if the SPX could end the week with 4340 in the rear-view mirror, so to speak.

As it is, even with Thursday’s slide, the SPX is only about 1% below all-time highs posted Wednesday. It’s natural to see some selling pressure at this point, considering how long the rally has lasted.

Big banks took the brunt of Thursday’s selling. Some of the suffering came in shares of Bank of America (NYSE:BAC) and JP Morgan Chase (NYSE:JPM), which both fell 2% yesterday. Even with today’s bounce, yields are back where they were in February, and the yield curve (or the gap between long- and short-duration rates) has narrowed sharply. That tends to pressure banks’ margins. It will be interesting to get their executives’ take on the situation when the biggest U.S. banks report earnings next week.

We’ll also get some key inflation data next week (see more below), so that might be on peoples’ minds. Inflation recently rose to levels not seen in decades, but a lot of that was the function of comparisons vs. last year’s lockdown period. Some analysts think inflation could continue to look high in the near-term but slow down in months to come.

h2 When The Bond Market Speaks.../h2

In the meantime, you can’t ignore what the bond market is telling us. In some ways, this nearly 50 basis-point drop in yields from the March highs is a little more worrisome than the rally that led us to those highs. Worries about inflation and overheating growth helped spur that upward move, but those are both functions of a strong economy. Cyclical sectors like energy, financials, and small-cap stocks benefited even as inflation fears mounted.

If the bond market is right this time, there’s far more to be concerned about, arguably. Unemployment remains high from a historic level and government stimulus has started to die down. The Fed, as it’s told us before, can only do so much to stimulate growth, but it’s hard to imagine another big push for stimulus checks. Any progress now in the bipartisan infrastructure package might get a positive read from Wall Street, however.

Today doesn’t promise much in the way of economic data or earnings news. All of that comes next week. So let’s see if stocks can gather some strength going into the weekend or if the pressure continues. It might also be worth checking futures prices Sunday night for clues about what investors anticipate ahead.

One thing to potentially be on the lookout for today (and next week) is any comments from Fed officials. It’s a little bit of a quiet period so any piece of news from the Fed could be met with a strong reaction. This is really a guessing game of what the Fed does next and how to get ahead of it.