The start of this abbreviated trading week is not looking good. Currently, the S&P 500 futures are down 38 points and are trading 0.9% below fair value, the Nasdaq 100 futures are down 145 points and are trading 1.2% below fair value, and the Dow Jones Industrial Average futures are down 345 points and are trading 1.0% below fair value.
The primary catalysts for the negative disposition are debatable, yet they generally fall along the following fault lines:
- A continued increase in Treasury yields as market participants fret the possibility of the Fed taking rates higher than previously expected and keeping them higher for longer than previously expected
- Disappointing full-year guidance from Dow components Home Depot (HD) and Walmart (WMT), which has prompted added concerns about the pace of future consumer spending
- Increased geopolitical tension between the U.S. and China, and between the U.S. and Russia, regarding the Ukraine war, which is nearing its one-year anniversary
The more concise summation is that the confluence of these factors is contributing to the consolidation trade that has taken root over the last few weeks.
Market participants are lowering their risk exposure. It is premature to say that it is an entirely risk-off market, especially with Treasury yields rising and not falling, yet there is nothing that is premature about taking some money off the table following a period in which the Nasdaq Composite, Russell 2000, S&P Midcap 400, and S&P 500 gained as much as 17.2%, 14.0%, 12.7%, and 9.3%, respectively, since the start of the year.
Those highs were all established either the day before, or the day of, the much stronger-than-expected January employment report. Since then, there has been a significant repricing in the Treasury market.
The 2-yr note yield stood at 4.08% the day before that employment report. Earlier this morning, it hit 4.68%. The 10-yr note yield stood at 3.40% the day before that employment report. Earlier this morning, it hit 3.90%.
The 1-yr T-bill yield, meanwhile, moved from 4.68% to 5.08%. For some worthwhile context, the S&P 500 dividend yield is currently 1.70%, so the competition factor for stocks provided by bonds is in plain sight.
The rally in January was exacerbated by short-covering activity and a fear of missing out on rebound gains, which was the byproduct of an emerging belief that the Fed would be pausing its rate hikes soon and even cutting rates before the end of the year.
Those assumptions have been re-thought following the arrival of some stronger-than-expected economic activity (e.g., employment, weekly initial jobless claims, ISM Services, and retail sales), some less-than-pleasing inflation data for January, and some more hawkish-sounding chatter from several Fed officials.
Another important inflation report awaits the market this week. The January core-PCE Price Index, which is part of the January Personal Income and Spending Report, will be released on Friday. That is the Fed’s preferred inflation gauge, which guarantees that it will have market-moving impact.
For now, the standing of the equity futures market has created a de-facto guarantee that the major indices will be losing ground at the open after having made up a big chunk of lost ground before the arrival of the January employment report, which forced a re-think of the leading, and friendly Fed, narrative to start 2023.
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Originally Posted February 21, 2023 – Losing ground as easy as 1-2-3
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