Friday’s employment report was the icing atop last week’s stellar rallies in both stocks and bonds. The key question for investors is whether these moves mark a significant turning point or simply relief rallies.
As we noted on Friday, the smaller than expected gain in Nonfarm Payrolls and the slight uptick in the Unemployment Rate were the catalysts for a reassessment of Federal Reserve interest rate policy over the coming months. The only reason we didn’t see an even bigger rally when Fed Funds futures largely priced out the possibility of another rate hike and thus priced in a lower terminal rate was that we had already risen quite far in a short period of time.
One could not be blamed for expecting a bit of consolidation after the recent jumps. The S&P 500 (SPX) jumped about +5.8%, the NASDAQ 100 (NDX) was up about +6.5%, and the Russell 2000 (RTY) leapt about +7.5%. Meanwhile, Treasury yields plummeted, with the 10-year dropping by 26 basis points and the 2-year falling by 16bp. The latter move was mostly accomplished on Friday thanks to the re-rating of the chances for rate hikes and cuts.
Some commentators said that Friday’s 15bp drop in 2-year rates signaled that the market now believe that cuts are imminent. I would argue that 2-year rates were already pricing in cuts, since their prior 5% level was already below the 5.375% Fed Funds midpoint. Thus, some cuts were priced in. Instead, the drop reflects the pricing out of future hikes. The distinction is subtle, but meaningful.
Regardless of rationale, the relatively precipitous drop in 2-year yields raises a fundamental question: can we be sanguine about prices for risky assets if the market has difficulty pricing relatively risk-free assets? This is a question that we have raised at various points in the past.
Lower rates are unequivocally a positive for equities in this environment, but last week’s stunning drop in VIX (Cboe Volatility Index) from 21.27 to 14.91 showed a sea change in sentiment. Investors wanted volatility protection at the end of the prior week but shunned it by the end of last week. Bearing in mind the VIX is designed to measure the market’s best estimate of volatility over the coming 30 days, equity options traders have clearly slashed their volatility estimates even as low-risk, short-term notes showed higher-than-usual volatility.
We will get a stern test of the bond market’s desire for Treasury notes and bonds. The Treasury will be auctioning 3-year and 10-year notes and 30-year bonds on sequential days starting tomorrow. It is quite reasonable to expect that the 3-year notes will be easily absorbed, but there are larger questions about the demand for the 10-year and 30-year securities given the recent volatility and some recent poorly received auctions. This week’s economic calendar is relatively light, but the auctions take precedence.
Seasonality is definitely playing into equity investor sentiment. Of the last 10 Novembers, SPX was higher in 9 of them. The only outlier was 2021, when SPX fell -0.83%, though the index rose by only +0.5% in 2015 and +0.28% in 2012. Over that period, November has an average monthly gain of 2.69%, the highest month of all. So far, we’re up 4% for the month, but investors remember last year’s +5.38% jump and 2020’s +10.75%. (Of course, last year SPX fell -5.9%, nearly wiping out the November gains…)
Also of note is that we are quite close to wiping out our pattern of monthly lower highs and lows. We recently noted that it was setting up a potential topping pattern on a longer-term basis. The intraday high for SPX in October was 4393.57. Friday’s high of 4373.62 means that it would not be difficult to surpass that level. Considering that October’s low was 4103.78 and November’s low so far is 4197.74, a significant reversal would be required to continue the August-October pattern.
Thus, it is reasonable to think that we have put in medium-term bottom. Good feelings abound in a wide range of key investments and sectors. But it is also difficult to assert that we have seen a definitive low. The flip from nervousness to complacency seems a bit extreme, especially ahead of a consequential series of Treasury auctions. We’ll know how the market digests those – and whether the good feelings persist – as the week progresses.
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