3 Questions We Want Answers To
For the past few weeks, I have been discussing how market participants are taking a wait-and-see approach to the US stock market.
This has locked the S&P 500 in a sideways trading range since the summer:
There are three key questions about upcoming, potentially market-moving catalysts, and we are on the verge of getting answers:
Tech earnings. This week, major tech companies began reporting earnings. Investors are watching this space closely to see whether AI revenue growth continues at a rapid pace or whether issues in the economy are starting to weigh on it.
The Federal Open Market Committee (FOMC) meets October 27-28. US Treasury bond yields have been rising, in part due to inflation fears and worries that the Fed is making a policy mistake by not raising rates.
The midterm elections. As I have discussed numerous times, the fourth quarter of a midterm year and the year that follows have historically been a very good time to own equities.
Right now, we are in the sideways, slightly more volatile range typical of past midterm cycles:
What to Watch For
High-yield bond spreads have been widening since the end of September as perceived risk to the economy has increased. As bond investors worry more about future risk, such as persistent inflation, they demand a higher yield
As bond investors worry more about future risk, due to, for example, persistent inflation, they want to be rewarded with a higher yield.
This has caused high-yield spreads, the difference between risk-free and high-yield rates, to widen:
If investors begin to feel that the issues facing the economy are being resolved, we should see these spreads start to narrow again.
However, if investors feel that the issues are being ignored, we may see a continued widening of spreads, which may scare equity investors.
I always watch the relationship between high-beta and growth areas of the market and their low-volatility and value counterparts:
High-beta and growth names have been seeing a decline in momentum and relative strength, while low-volatility and value names have been improving. This indicates that investors want to own the “safer”, less volatile areas of the market.
We are nearing the point where, if equity investors feel comfortable with the answers to their three questions, we should see bargain hunting in high-beta and growth areas, such as semiconductors, which are down more than 25% from their June high:
In this week’s sector rotation report, I noted that we are at an inflection point as value sectors are nearing overhead resistance and many growth areas are nearing support levels.
For example, the technology sector is currently trading near cloud support and at a level where buyers have previously shown up:
There is a lot to watch over the next few weeks. I’ll keep you posted on what I am seeing in the credit market and in the rotation of the market.
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