Oil craters back into the low $80s … Luke Lango’s take on the 10-year Treasury yield … the dollar isn’t showing signs of slowing … the S&P is bouncing off its 200-day MA
Well, the Federal Reserve has its work cut out for it.
This morning, we learned that the labor market remains red hot. Here’s CNBC:
Job growth was stronger than expected in September, a sign that the U.S. economy is hanging tough despite higher interest rates, labor strife and dysfunction in Washington.
Nonfarm payrolls increased by 336,000 for the month, better than the Dow Jones consensus estimate for 170,000 and more than 100,000 higher than the previous month…
Not only did the number top forecasts, but this was the largest payrolls increase since January.
On one hand, this is good news because it shows the U.S. economy isn’t facing an imminent recession. On the other hand, it’s bad news in that it increases the likelihood of further tightening from the Fed.
We can see this by looking at the CME Group’s FedWatch Tool. This shows us the probabilities that traders are assigning to various interest rates at different dates out in the future.
Whereas yesterday, traders put 29.8% odds on the likelihood of the Fed raising rates a quarter point by its December meeting, those odds have jumped to 38.8% in the wake of this morning’s jobs report.
Meanwhile, the going expectation that the Fed would leave rates unchanged in December dropped from 67% yesterday to 54.8% as I write.
Now, we’ll get to the impact of this morning’s jobs report on bond yields in a moment. But let’s begin with some more encouraging news.
At least oil prices are cratering
Last week, the price of West Texas Intermediate Crude closed at $93.68. As I write Friday, it’s fallen nearly 13% to $81.81 due to growing fears of a global economic slowdown.
If our hypergrowth expert Luke Lango is right, we don’t have to worry about another price surge.
Let’s jump to Luke’s Daily Notes in his Innovation Investor service:
We think the late summer oil price surge is over.
The reality is the oil prices have been reflective of a tug-of-war between OPEC+ reducing supply and the Fed reducing demand. As it turns out, because the world economy is built on debt, the Fed is much more powerful than OPEC+.
Oil prices surged in the third quarter because the Fed basically took the quarter “off.” Now, the Fed is punching back with hawkish rhetoric, and it’s killing oil prices. Technically, the uptrend is broken and oil prices will continue to roll over.
Disinflation is back.
Regular Digest readers recognize lofty oil prices as one of the “Toxic Trifecta” that have been weighing on stock prices. With oil prices tanking, let’s look at the other two, beginning with the soaring 10-year Treasury yield.
This morning’s jobs report has spiked the 10-year yield even higher
As we’ve detailed here in the Digest in recent days, the 10-year Treasury yield has been surging in recent weeks. It’s now climbed to the highest level since 2007, and this morning’s jobs report didn’t help. As I write, the 10-year Treasury yield has popped to 4.80%.
Let’s return to Luke’s Daily Notes for his take:
Although yields dropped [yesterday], they remain at 15-year highs and are far too high for current stock market valuations.
Either the 10-year Treasury yield has to decline to 4%, or the forward price-to-earnings (P/E) multiple on stocks has to move down to 16X/17X.
Until we see convincing evidence that yields are on their way down to 4%, we will stay bearish on the valuation outlook for stocks.
In yesterday’s Digest, we did a deep dive into the painful impact of the 10-year Treasury yield on stocks. The question now is how high will this yield go?
One bond expert, Jim Bianco of Bianco Research, thinks we’ll be above 5% very soon. Bianco puts the blame at the feet of the Fed – not because of its hikes so far, but because of its mixed messaging.
Here’s CNBC:
“I don’t think we’re near the end of this move in the bond market,” the Bianco Research president told CNBC’s “Fast Money” on Tuesday.
If the Federal Reserve hints about ending interest rate hikes while investors still sense inflation, Bianco warns they won’t buy bonds.
“That’s what I think has been killing the bond market,” he said. “The more the Fed talks about being done, waiting [and] assessing all the rate hikes they’ve done — the more that they’re making it worse.”
Bianco thinks we’ll see a bond market capitulation when investors finally throw in the towel:
Most of the year bond investors [and] bond managers have been long.
They’ve been trying to argue why we’re going to have a recession. Why there’s going to be a rally. And, they’ve been getting their brains beat in, and they can’t take it anymore.
There’s an old investment axiom suggesting the market will move in whatever direction hurts the greatest number of people. As Bianco noted, most bond traders weren’t prepared for soaring treasury yields this year.
If we put these ideas together, it means get ready for a 5%+ yield very soon.
What’s been happening with the third part of our Toxic Trifecta – the soaring U.S. dollar?
In the same way that stock prices don’t respond well to surging Treasury yields, neither do they like a strengthening U.S. dollar. As we’ve detailed in prior Digests, a stronger dollar creates currency headwinds for international companies that generate significant revenues overseas.
Roughly 40% of the S&P’s revenues are generated outside U.S. borders. For the tech sector, that exposure jumps to nearly 60%. A strong dollar erodes the buying power of those foreign revenues.
So, what’s the latest for the U.S. dollar?
Well, it’s still climbing. Worse, it just steamrolled through a horizontal resistance point.
Below, you can see the dollar breaking out since this summer.
At the end of September, this march north was approaching the dollar’s high from March. The hope was this level might act as a ceiling, rebuffing the dollar’s advance.
As you can see below, that didn’t happen. The dollar is showing little sign of slowing down.
Look again at the chart above and you’ll see that the dollar began surging just as Q3 began. We’ll be listening to hear if C suite-level managers begin referencing this dollar strength on their Q3 earnings calls next week.
Regular Digest readers know we’ve been skeptical about robust earnings growth projections from analysts. This wrecking ball of a dollar is yet another reason why.
Netting out our Toxic Trifecta, the edge remains with the bears, but the S&P still has one last line of defense – and it appears to be working
That’s the 200-day moving average.
For context, let’s jump back to our Digest from Tuesday of last week:
The S&P faces two major tests that will make or break its short-term direction.
The first is its multi-month trendline.
As you can see below, the S&P is about to test the backbone of this year’s bull market.
[If we fall below this multi-month trendline] we’d be looking to see if the S&P can find support at its long-term 200-day moving average (MA).
To make sure we’re all on the same page, a 200-day MA is a line on a chart showing the average of the prior 200 days’ worth of asset prices. It’s an important psychological line-in-the-sand for investors and traders.
When the asset’s price is above the 200-day MA, many traders interpret it as a sign that sentiment is bullish. The bearish opposite is true when asset prices are below this level.
Since many trading algorithms base their buy-and-sell decisions on the interplay between an asset’s price and its 200-day moving average, this is an important long-term technical level.
As you can see below, though the S&P lost its trendline earlier this week, it’s still holding above its 200-day MA.
Better still, as today’s session has turned bullish, not only has the 200-day MA held, but the market strength has pushed us back to the trendline.
Luke believes this is the beginning of a real bounce. Let’s return to his Innovation Investor Daily Notes:
The S&P 500 has dropped into the “major support zone” between 4180 and 4220.
And given a sub-30 relative strength index (RSI) reading and very negative moving average convergence/divergence (MACD) oscillator, it looks increasingly likely that stocks bottom here.
We really like the technical setup for a bounce and think it’s time to buy the dip.
It’s certainly encouraging to see the market soaring as I write Friday, despite being deep in the red pre-market this morning. If bulls can hold this 200-day MA and turn it into a springboard, we could be in for a fierce rally next week.
Let’s end today while maintaining our optimism. Here’s Luke’s forecast for what’s headed our way:
The summer of reinflation is over. And so is the wave of hot economic reports.
Going forward, the economic and inflation data will paint a picture of a Goldilocks economy with moderating growth and slowing inflation – exactly like we saw throughout the first half of 2023.
We’re confident that, thanks to that moderate data, stocks will rally strongly off major technical support levels and bounce significantly higher into the end of the year.
Have a good evening,
Jeff Remsburg
