The Markets Are Looking Angry

Bonds keep going for a ride... Stocks are sitting on a key level... An indicator worth watching... The trigger for this Washington crisis... How it's all connected...

The bond market continues its wild ride...

If you listen in on the crowd today, rising long-term bond yields in the U.S. and around the world have more and more investors on Wall Street wondering if or when another shoe is going to drop for stocks or the global economy in general...

Here's market analyst Samantha LaDuc on the social media platform X (formerly Twitter) expressing the most prevailing worry among investors today. She describes what sounds like a breaking point...

Markets are watching the 10-year melt away and they're starting to panic as 10s are the collateral for the whole financial system and there are now hundreds of $ billions of MTM losses suffered through the collateral stack...

The "MTM" refers to unrealized mark-to-market losses.

Regular readers might remember them as the featured antagonist in the bank crisis earlier this year. As our friend Joel Litman, founder of our corporate affiliate Altimetry, shared with you just this past weekend in a Masters Series essay...

Basically, mark-to-market accounting requires companies to value their assets and liabilities at their current market price, rather than their historical cost. Stocks "mark up" and "mark down" constantly throughout the day. (This is what's referred to as "marking.")

Back in March, enough folks with enough money in a few regional banks, most notably Silicon Valley Bank, got very concerned once they learned their bank was sitting on way more losses.

The catalyst was the Federal Reserve's benchmark bank-lending interest rate going from near 0% to close to 5% in a little more than a year – that pushed the value of bonds held by banks way down. Some handled this scenario better than others.

In any case, enough people got scared for their deposits and went on a few good old-fashioned bank runs, which rattled the market for a few days – until the Federal Reserve and Treasury Department stepped in on a Sunday night with emergency rescue operations.

Things like this could happen again...

Think of March's bank panic – and other possibly unimagined consequences – playing out more and more if rates go higher... and banks, institutions, businesses, and governments sit on possibly billions of additional unrealized losses.

Let's not forget that the past 15 years featured ultra-low rates and low inflation. We're seeing the opposite now.

This is one reason I (Corey McLaughlin) suspect the Fed has decided twice this year to "pause" interest-rate hikes... and why central bank Chair Jerome Powell has increasingly said the Fed is now weighing the risks of doing damage to the economy if it keeps raising rates to fight inflation.

This scenario also aligns with Joel's concern about the broad markets over the next several years and why an upheaval in the debt (credit) market is likely ahead because of a higher-interest-rate environment that's only just beginning.

Joel talked about this in his must-see presentation last week. Importantly, he also offered up a strategy for how you can take advantage of the fallout of what he thinks is to come – to make potential triple-digit capital gains and find double-digit yields.

Click here to learn more.

So, in short, we'll keep watching bond yields...

Today, the two-year Treasury was down about four basis points to 5%... and the 10-year Treasury was slightly down to 4.71%. Yet the 30-year Treasury was up two basis points to 4.89%. This may actually be an encouraging sign and shows more "reversion" of the yield curve, meaning shorter-term yields on a path of being lower than longer-term ones again. This has typically happened before recessions.

That's normal. This may be a sign of the bond market settling down and accepting new expectations for higher interest rates... and higher inflation... for longer. It may also reflect recognition of a worsening economy in the shorter term, as more and more signs predict a weakening job market. That would cause the Fed to cut its federal-funds rate, which short-term yields tend to track.

Should longer-term rates keep going even higher, though, more pain could be ahead for the markets... and what this means for stocks remains to be seen.

As our Director of Research Matt Weinschenk wrote just a few days ago in the latest edition of our Portfolio Solutions products...

Stock markets don't like high interest rates, for two simple reasons...

1. Higher interest rates make the future earnings of companies less attractive.

2. The higher yield on a bond looks more enticing compared with the expected return on a stock, so money moves from stocks to bonds.

For instance, the S&P 500's dividend yield is about 1.6%. The yield on a two-year Treasury note today is roughly three times higher. Treasurys offer an enticing "risk free" return if you're skeptical about the growth outlook for 2024 and beyond... or if you're tired of fretting about risks in stocks or other asset classes (and believe Uncle Sam will keep paying).

We'll be watching other indicators as well...

Some sentiment indicators are showing stocks are already at "oversold" levels, and the benchmark S&P 500 is sitting right above its 200-day moving average, the technical measure of a long-term trend. The index is also just above its previous highs around 4,200 in February, which could be a key "support" level.

Should stocks break below, though, look out.

Our friend Jeff Havenstein, an analyst on Dr. David "Doc" Eifrig's Retirement Millionaire team, wrote in yesterday's edition of Doc's free Health & Wealth Bulletin e-letter about another indicator that has his attention: the advance/decline line. As Jeff explained...

To recap, one of the simplest ways to know a market is healthy is to make sure more stocks are going up versus going down. This is what the advance/decline (A/D) line looks at.

The A/D line takes the number of stocks that went up in a given day and subtracts the number of stocks that went down. If more went up during that day, the line goes up. If more went down, the line goes down.

In a typical bull market, as stocks rise, the A/D line usually goes up, too. When the A/D line moves lower while the market continues to go up, it's time to worry. It means that gains in stocks are concentrated in only a few companies.

Back in June, for example, the tech-heavy Nasdaq was surging on the backs of the so-called "Magnificent Seven," but the A/D line was heading lower. That foreshadowed the sell-off of the past few months. We're still seeing this behavior today.

What's concerning to Jeff is that the biggest tech stocks – Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Nvidia (NVDA), Tesla (TSLA), and Meta Platforms (META) – also make up more than 25% of the S&P 500. And as Jeff said...

Taking a look at the S&P 500 A/D line, it has been heading lower over the past few weeks. But the index is still only a bit off its highs...

We'll have to see if this trend continues. It's definitely worth keeping an eye on... At the very least, it has me a little more cautious than normal on the outlook for the market.

As we've also explained this week, tomorrow's jobs numbers reflecting September could play a significant role in the path of the markets in the near term.

In August, the unemployment rate ticked higher to 3.8%. That's up from a cycle low of 3.4% in April. Any rate higher than last month could set off alarm bells that a recession is ahead or already underway.

Meanwhile, the folks in D.C. aren't doing the market any favors...

Down Interstate 95 from our Baltimore office, congressional behavior in Washington has hit new lows. And that's saying something. The House of Representatives is without a speaker during a term for the first time in 100 years. That means no business can get done at all.

As I wrote last week, money is the trigger for this part of the D.C. circus...

A small but powerful-enough slice of the Republican party has been stumping for deep budget cuts. That put the prospect of a government shutdown on the table last week and led to now-former House Speaker Kevin McCarthy being ousted from his position.

As we wrote in the September 26 Digest...

Negotiations are entirely reasonable. Our country's debt load stands at more than 100% of GDP, and inflation remains a problem. McCarthy is trying to broker some kind of deal, which may cost him his job. Meanwhile, the Senate is reportedly working on its own stopgap agreement.

Odds are something will get done. These days, things only happen in D.C. when deadlines are near.

But do you see how it goes when just a few people in Congress say no to more spending? The whole thing goes off the rails, and the government is on the verge of its fourth shutdown in the past decade.

That's still true...

And this train is even further off the rails today...

A government shutdown is still a possibility in about a month, which is when the current short-term funding deal runs out. It might be more likely to happen now, without a speaker of the House in place and Republicans prepping to debate a replacement for McCarthy.

And we probably don't need to tell you how much government activity accounts for GDP.

In the meantime, old spending – being covered by the "debt ceiling" deal from earlier this year – and old stimulus (and inflation) are already causing trouble in the bond market. It's all related. As I wrote yesterday, but is worth repeating...

At the same time, the Treasury Department is unloading a lot of new bonds into the market to finance Uncle Sam's ballooning debt... And the Fed has been reducing its Treasury holdings as part of its effort to slow the pace of inflation...

These big-time factors, a greater supply of Treasurys along with shifting market expectations and lower demand, are pushing yields higher (and prices lower) because not enough investors are as interested in longer-term bonds today as they were before.

With more investors thinking that interest rates will be higher for the foreseeable future, they are realizing it makes no sense to hold bonds that yield lower today... and the ripple effects are being felt across the markets.

New 52-week highs (as of 10/4/23): CBOE Global Markets (CBOE), Costco Wholesale (COST), and Construction Partners (ROAD).

In today's mailbag, some thoughts on rising interest rates... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"I lived through the late '70s and early '80s. Bought two houses and sold them both for a profit. In the early '80s I was not able to qualify for a 30-year fixed-rate mortgage or afford one. I could only get a 5-year balloon note. This is much easier to afford because the monthly payments were mostly interest. The whole cost of the house was not amortized but due in 5 years as a balloon payment (to be refinanced). This is how the bankers and realtors got us through the difficult times of 10%-plus long-term mortgages and they were able to make money too. It worked. Our family got into a house with affordable payments.

"This era will work out too. It's called 'creative financing.' I'll bet 5 years from now rates will be lower, maybe not back to 3% mortgages like the 1950s or 2021, but lower than 7%+ today.

"The loans of that era were much better than the NINJA (No Income No Job No Assets) loans of 2005-2008 that were then collateralized and created the 2008 bust. The balloon notes of the '80s just gave some time for rates to settle out and still let people afford houses even with a dagger hanging over their head if rates did not go down but they did go down." – Stansberry Alliance member John P.

All the best,

Corey McLaughlin
Baltimore, Maryland
October 5, 2023