September has been a story of higher-bond yields, a stronger dollar, and spiking oil prices. The higher these assets climbed, the lower the stock market fell. And now we enter October, a month that is notorious for providing negative returns at least in the first weeks of the month.
"Tread cautiously" was how I described September-October several weeks ago. History indicates that those are the two worst months for stocks. So far that advice has proven accurate. The stock market has had its worst decline all year and the prospects that this sell-off will continue are high despite the dead cat bounce we are enjoying right now.
While yields, the dollar, and oil are separate asset classes, they are interrelated when it comes to explaining the "why" of this present downturn. Let's start with the price of oil. As I explained last week, since oil is used worldwide in practically everything it is an important element in gauging future inflation.
Oil is now trading above $90 a barrel and some expect it to hit $100 a barrel shortly. The spike in energy prices therefore has convinced many traders that the decline in inflation we have enjoyed may reverse and as it does bond yields need to rise to compensate for the real rate of return bond holders should demand.
In addition, readers may recall my warning that the U.S. Treasury needs to replenish the government's general account by auctioning more than a trillion dollars in various bonds. In anticipation of that auction program, bond traders had already pressured yields higher.
By the way, that avalanche of government bond issuance will begin in earnest during this quarter, so yields could continue to move higher. As it is, the U.S. 10-year Treasury is yielding 4.60 percent, its highest level since 2007 while mortgage rates have hit a 23-year high.
The U.S. dollar has strengthened to 10-month highs as yields have risen. Currency traders still expect that the U.S. economy will remain more resilient to higher interest rates than other economies. The combination of all three elements has conspired to pressure stocks downward.
By mid-week the markets were exhibiting extreme oversold readings. Sentiment as measured by the AAII Sentiment Survey gave the highest bearish reading and the lowest bullish score since May 2023. The "Fear" Index, according to CNN, was showing extreme fear.
These are all short-term contrarian indications that tell traders to expect a countertrend bounce. Yields fell slightly and the dollar followed suit which gave equities some breathing room to rally. Stocks could continue higher for a day or two, especially on the back of the latest Personal Consumption Expenditures Index (PCE), which is the Fed's preferred inflation measure. The PCE came in cooler than expected. The Algo traders took that to mean inflation was not as strong as the markets expect and pushed stocks higher.
I still think the markets have more to fall before this sell-off is said and done. The 200-Day Moving Average for the S&P 500 Index is about 125 points below at 4,200. However, stocks do not usually bounce off that line perfectly. Many times, the averages will overshoot to the downside, so that we could see 4,100 or maybe lower before we regain the 200 DMA.
It is a process that I am expecting to play out between now and the second week of October before we begin to rise once again. But to do so, we would need to see yields drop as well as the dollar. If things do develop the way I see it, I would be a big buyer of that pullback, but probably not in the same sectors that had been winners in the first half of the year. A declining dollar and lower yields would be beneficial to overseas markets, especially emerging market countries, as well as mines and metals, precious metals, and other sectors that have an inverse relationship with the dollar.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at firstname.lastname@example.org.
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