Remember, “Don’t Fight the Fed”

U.S. equities finished sharply lower on Thursday as the bond market displayed weakness, pushing long-term interest rates higher. After months of a “deflationary” decline in yields, as bond traders seemed to be warning the Federal Reserve away from its aggressive policy tightening, non-stop hawkishness from Federal Reserve policy makers have apparently spooked the market.

Selling is intensifying now, pressuring “risk parity” funds that depend on the normal inverse correlation between bonds and stocks; undone by the fact that both are weakening now at the same time.

In the end, the Dow Jones Industrial Average lost 0.7%, the S&P 500 gave back 0.9%, the Nasdaq Composite wafted 1% lower and the Russell 2000 finished the day down 1.4%. Treasury bonds were mostly weaker, the dollar was down, gold gained 0.1% and crude oil rose sharply, but was unable to hold its gains finishing up just 0.9%.

Breadth was heavily negative with decliners outpacing advancers by a 4.3 to 1 ratio with volume at nearly 90% of the NYSE’s 30-day average. Defensive utility stocks led the way by holding their decline to 0.1%. Yield-sensitive telecom and REIT stocks were the laggards, down 2.3% and 1.9%, respectively.

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Tesla Inc (NASDAQ:TSLA) fell 5.6% after a WSJ article highlighted key challenges facing the company including uneven production output and increasing competition amid stretched valuations and red-hot sentiment.

Shares are suffering a nasty technical breakdown, down more than 20% from their recent high to collapse back to levels not seen since late May.

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The selling is becoming more widespread, taking down several mega-cap blue chips including General Electric Company (NYSE:GE) and International Business Machines Corp. (NYSE:IBM).

In fact, at 1,827 net declining issues on the NYSE, today’s selloff was the most severe since December. The increasing volatility is great news for the iPath Short-Term VIX (NYSEARCA:VXX) recommended to Edge subscribers, which is up 10% since recommended last week.


Technicals look poor here as well, with sentiment off the charts extreme and market breadth very poor.

According to the team behind SentimenTrader, for the first time since November 2014 both their “smart money” and “dumb money” confidence indicators are above 60%. This is “highly unusual” in their words, with just 39 days in total showing a similar dynamic since 1999.

The subsequent trading was heavily skewed to the downside: Over the next 30 days, the S&P 500 showed a gain after just six occurrences (a 16% win rate for those keeping score) with an average return of -3.4%, a downside risk of -7%, and a upside reward of 2.2%.

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The catalyst seems to be the risk that Treasury bonds fall out of their eight-month rebound pattern. Higher long-term interest rates will pressure the bond market broadly, crimp credit costs in the economy, and represent a rare dose of asset price deflation into the psyche of bulled up investors.

And remember: This is exactly what the Federal Reserve wants as it battles the fact financial conditions have actually loosened since they started tightening policy in 2015. As they say, “Don’t fight the Fed.”

Check out Serge Berger’s Trade of the Day for July 7.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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Anthony Mirhaydari is founder of the Edge (ETFs) and Edge Pro (Options) investment advisory newsletters. A two-week and four-week free trial offer has been extended to Investorplace readers.

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