• Funds Blog
• December 29, 2024

US Stocks Decline, Yet Further Drops Are Unlikely

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In a significant turn of events, the Federal Reserve's latest meeting minutes revealed a hawkish tone that has reverberated through financial markets, triggering a substantial rise in U.STreasury yields and causing widespread turmoil in asset pricesThe Nasdaq 100 index has been particularly hard hit, recording a decline of over 3.2% as of the close on August 17, marking its third consecutive day of lossesThis episode has left investors questioning the stability and direction of key markets as sentiments shift towards caution.

Interestingly, on the same day, the Atlanta Fed's GDPNow model adjusted its forecast for the U.Seconomy, predicting a robust 5.8% growth rate for the third quarterSuch figures would typically be welcomed as indicative of economic strengthHowever, this optimism comes together with the looming pressure of potential interest rate hikes from the Federal Reserve

Indeed, by August 17, the yield on 10-year U.STreasury bonds surged past 4.3%, reaching a peak not observed since October 2022 and propelling real interest rates to their highest levels since 2009. Concurrently, the two-year Treasury yield exceeded 5%, fueling concerns among investors.

Market reactions over the past week underscore a growing unease as participants brace for a future defined by tightening monetary policiesThe dollar index, reflecting the strength of the U.Scurrency, has also experienced a notable upswing, closing around 103.45, marking four consecutive days of gainsSuch shifts in asset classes reflect an underlying sentiment adjustment; investors grapple more seriously with the prospect of an economic landscape influenced by aggressive rate increases.

Further compounding this atmosphere of uncertainty is the Federal Reserve's recent articulation of the need for continued hikes to combat persistent inflation, highlighted in the minutes from their July meeting released on August 17. The discussions revealed that a majority of Fed officials are concerned about inflation remaining significantly above their long-term goals, exacerbated by a tight labor market

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These inflationary pressures continue to pose an upward threat, potentially necessitating a more proactive monetary policy stanceThis landscape has resulted in the Nasdaq leading a broader market downturn, with commodity prices, notably oil, also showing signs of weakness.

The implications of these developments extend beyond mere fluctuations in stock pricesThe persistent rise in Treasury yields has had a pronounced impact on financial market dynamics, effectively shaking the foundational logic that has guided investor behavior in recent monthsIn fact, the surge in yields began shortly after Fitch downgraded U.Sgovernment bonds earlier this month, amplifying concerns within financial circles.

As of August 18, the yields continued their ascent, with the 10-year Treasury yield nearing the 4.3% mark while the two-year yield firmly sat above 5%. This persistence raises critical questions about the sustainability of these rates and their potential implications for key asset classes, particularly equities

Notably, prominent hedge fund manager Bill Ackman has taken a bearish stance on 30-year U.STreasuries, predicting a long-term inflation rate near 3%, rather than the Fed’s 2% targetSuch bearish sentiments reflect widespread skepticism regarding the Fed's ability to manage inflation effectively without stifling economic growth.

As the U.Sequity markets grapple with these dynamics, the S&P 500 index faces significant pressure following a remarkable rebound from its lows last OctoberThe index surged over 30% since then and more than 20% since MarchHowever, there are growing concerns that such explosive growth may not be replicable in the latter half of the yearWith its inability to test the March highs, bullish sentiments are tempered, prompting questions about the readiness of an increasing number of short sellers waiting on the sidelines to take advantage of any price dropdown

Large speculators had reached historical highs in their net short positions against the S&P 500 futures, intensifying market dynamics where a significant price drop could serve to either validate or invalidate these positions.

Moreover, on a technical analysis level, the S&P 500’s price closed below its trend support, further complicating the market's sentiment landscapeShould market conditions remain fragile, short sellers might set stop-loss orders above recent highs, targeting a brief return to the 4300 support zonesMarket participants are acutely aware that movements are seldom linear, and many may choose to observe for signals of a rebound toward resistance areas before committing to aggressive selling strategies.

Michael Burry, known for his prophetic warnings during the 2008 mortgage crisis, has also stepped back into the limelight with substantial bets against both the S&P 500 and the Nasdaq 100 ETFs, reflecting concerns about the overvaluation of ostensibly safe index funds that house significant stakes in high-flying stocks like Nvidia and Tesla

His Scion Asset Management holds around 200,000 put options against SPDR S&P 500 ETF Trust, underscoring a strategic positioning against possible market declines.

In an overarching sense, despite these turbulent developments, there remains a belief that while a short-term pullback might materialize, the likelihood of a sustained downturn is presently lowInstitutional positions do not appear overwhelmingly levered, and the resilience of the U.Seconomy lends a certain robustness to equity marketsData provided by Bank of America indicates that retail investor engagement remains tepid, suggesting we are distanced from a peak market scenario characterized by universal enthusiasm around stocks.

Interestingly, the probability of a recession in the U.Sappears diminishing, in light of ongoing economic signals including declining inflation rates and a robust job marketInflation has notably eased from a peak of around 9% in June of last year to approximately 3% in June of this year—indicative of potentially reduced risks associated with Federal Reserve rate hikes and easing pressure on stock valuations

Recent consumer confidence data also signals a resilient economy, with the University of Michigan’s Consumer Confidence Index rising from a low of 50 last June to over 71.6 in July, revealing underlying strength in consumer behavior, which composes a substantial part of U.SGDP.

In the realm of commodities, the already volatile gold prices are currently facing significant headwinds, particularly with the upward trajectory of U.STreasury yield rates and a strengthening dollarThis culminated in rapid fluctuations for gold prices in recent days, where on August 17, spot gold dipped below the $1900 mark, hovering around $1893. For the first time since last December, gold fell below its 200-day simple moving average amidst persistent downward trends observed throughout AugustDespite a brief rebound after dropping through the $1900 threshold, further declines were induced by the Fed's unveiling of its meeting minutes.

Looking ahead, the two-year U.S

Treasury yield will likely play a pivotal role in shaping market dynamicsThe recent challenges in sustaining movements above the 5% threshold reflect concerns over longer-term trends, prompting considerations of whether we might witness a peak in Treasury yields soon.

If a ceiling for yields is established, it could afford some respite to previously pressured assets, including gold and certain currencies like the yen and the Australian dollarHowever, in light of the prevailing conditions with a robust dollar and increasing rates, confidence in gold prices reaching a bottom remains uncertain.

The $1900 to $1912 price range has emerged as a critical level for bullish sentiments, having absorbed substantial trading volume during March's recovery phaseThis area is anticipated to initially serve as supportYet, a breach beneath this threshold could catalyze a swift correction toward $1840. Ultimately, while current levels convey nuanced complexities across financial markets, ongoing developments remain under close scrutiny as stakeholders navigate an increasingly unpredictable landscape.

(The views expressed in this article are solely those of the author and do not necessarily represent the position of this publication