An Age-Old Warning Signal Worth Watching
All is well, right?... A key divergence in stocks and bonds... The age-old question... It's essentially 2022 all over again... But it's not all bad news... Another bearish trade...
Was that it?...
A day after all the major U.S. indexes sold off between 1% and 4% and the market appeared to reset interest-rate expectations for the next several months, the selling stopped.
Today, the benchmark S&P 500 Index finished 1% higher, the Dow Jones Industrial Average was up slightly, and the small-cap Russell 2000 Index (which was hammered the most yesterday) was up by more than 2%.
But as I (Corey McLaughlin) will explain, a "divergence" in the market is showing more volatility could be ahead... only many investors aren't paying attention to it.
On the one hand, the major U.S. stock indexes are still significantly higher than they were in late November and early December – even after yesterday's selling following Uncle Sam's "surprising" inflation data.
You see, until recently, the market expected multiple interest-rate cuts in the first half of 2024. But with "sticky" high inflation numbers, that monetary policy path looks unlikely now.
And with government-reported unemployment numbers remaining low and GDP growth positive, Federal Reserve Chair Jerome Powell said at the central bank's last policy meeting that the Fed wants more "confidence" in the path of inflation before it decides to cut rates.
Yet, on the other hand, bond prices (which trade inversely to yields) are already back to the same levels they were in late November and early December after yesterday's higher-than-expected consumer price index ("CPI") data.
So what gives?
It's the age-old question: Is the stock or bond market 'right'?...
As our colleague and Ten Stock Trader editor Greg Diamond has been explaining recently, the bond market tends to reflect economic realities earlier than the stock market, but the stock market eventually catches up to what bonds are doing.
As Greg wrote this morning in the free DailyWealth newsletter, a sister publication of ours...
Bond traders are the smartest people on the trading floor...
Or at least that's how the old saying goes on Wall Street.
The bond market tends to move based on economic developments – like higher or lower inflation – sooner than stocks do.
Bonds are more focused on overall economic health in the future... whereas the stock market can be driven by emotion and positioning.
Simply put, stocks and bonds both do a good job of discounting future economic developments, but bonds are usually ahead of the game.
It looks like we're seeing this concept play out again in real time, and it might mean the sell-off we saw yesterday could be the start of a bigger drawdown in the short term... a general pullback from the rally we've seen since November.
The notable 'divergence' in stocks and bonds...
Bond prices have been falling since the start of the year while the major U.S. indexes have headed higher. Greg says this relationship "may be sending investors a warning sign." As he shared in DailyWealth...
Here's a chart of the Nasdaq 100 Index and the iShares 20+ Year Treasury Bond Fund (TLT), which holds a basket of long-term Treasury bonds...
Why is this happening? Given today's market environment, Greg says...
When bonds top out and stocks keep rallying, the inflationary picture may not be as rosy as stock investors think it is.
Greg also updated Ten Stock Trader subscribers today on his expectation for a "turning point" in the markets, which he has been predicting for a while now. Kudos to him.
Typically, when you see this kind of divergence in stocks and bonds, one side ultimately gives, and it's pretty clear when the turn happens. It hasn't yet.
It looks like the same story as 2022...
The prevailing expectation for most of 2022 was that the Fed couldn't raise its benchmark lending-rate range higher and higher... to 3%... 4%... then eventually around 5%. But it did. We saw a similar divergence between bonds and stocks back then... And then stocks sold off.
As Greg wrote to Ten Stock Trader subscribers at 1:14 a.m. Eastern time today (the guy works tirelessly during times like these) about his call of a "top" in early 2022...
This divergence is what made stocks tank in 2022... It wasn't some secret club I was in calling for a top – it was the bond market!
We ended up seeing multiple "bear market rallies" that fizzled. That was because inflation numbers were "hotter" than expected until October 2022, when the market finally bottomed.
Today, we've seen several months of the Fed's preferred inflation numbers – the core personal consumption expenditures ("PCE") price index – on pace for the central bank's 2% annual goal. And more recent numbers have risen enough that full-year PCE (adding up the past 12 months) is at 2.9%.
The six-month number comes in at 0.9%, on pace for the 2% annual goal, but, again, Powell just got done telling the world that the central bank doesn't have enough confidence to ease monetary policy quite yet.
Maybe it will eventually, especially if we see a similar crisis to the one we saw last March in regional banks. But that's not the case right now.
In short, longer-term trends for stocks – I'm talking over the past 12 to 16 months – are bullish. We're not going back to 40-year high inflation anytime soon, at least, but high(er) inflation is sticking around longer than many on Wall Street thought. Investors were reminded of this yesterday.
One of the risks not fully priced into the market today is that the Federal Reserve's interest-rate policy stays right where it is for longer... and longer into this year. Even less baked into the market is the idea that rates could go even higher...
The bond market is saying it. The stock market, not as much yet. Both won't be "right" forever, and typically the bond market reflects reality first.
We might not be talking about a nearly year-long sell-off again...
Market "fear" in 2024 isn't nearly what it was in early 2022 when war broke out in Ukraine just as central banks started interest-rate hikes around the world to combat 40-year high inflation.
But it would be wise to expect more volatility this year as expectations around inflation and interest rates move around.
This Friday brings a round of producer price index ("PPI") numbers, which reflect costs for businesses. And the next PCE data, covering January, will come out on February 29.
Summing up, judging by the divergence pattern in bond and stock prices, the current period of volatility might not be done yet. One positive day for stocks and bonds following a bigger negative one doesn't change the story.
This might sound ominous...
But it doesn't have to be all bad news... You can use any future dips to buy a high-quality stock at a level you're comfortable buying... or to add to a position recommended by your favorite Stansberry Research editor.
Volatility also creates opportunities for short-term trades. For example, Greg's preparing his subscribers to profit from this volatility. He recommended one bearish trade yesterday and another today, each with the potential to double in the near term.
If you're interested in learning more, click here to hear directly from Greg about his market outlook and how to access his great work. And, as always, existing Ten Stock Trader subscribers and Stansberry Alliance members can find all of his research here.
New 52-week highs (as of 2/13/24): Eli Lilly (LLY), Travelers (TRV), Viper Energy (VNOM), and Waste Management (WM).
In today's mail, a question about inflation measures, which was part of yesterday's Digest... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Curious why no one includes CPI supercore in addition to headline and core? Some refer to supercore, but generally don't provide the monthly or [year-over-year] numbers." – Subscriber S.F.
Corey McLaughlin comment: Thanks for the note. For those that need a definition, what's referred to as "supercore" CPI data is a government measure of consumer prices excluding food, energy, and shelter.
To your question, S.F., I suspect that a lot of people ignore supercore CPI data because if a measurement doesn't include food, energy, and shelter prices – a huge chunk of personal or business costs – it might not appear relevant.
And it's possible to get enough of an idea of trends from headline numbers and a close analysis of the categories involved. The Fed also prefers to look at core PCE – whose data overlaps by about 50% with supercore CPI.
(Powell mentioned looking at supercore in one of his press conferences over the past year, but it didn't sound as significant as the importance of PCE to me.)
That's why I don't think I've ever written the words "supercore CPI" in these pages until now. It's just a matter of what you choose to look at.
However, supercore data is relevant to gauge costs in the service economy, like hotel fares and airfares, child care, and hiring a plumber or a house cleaner. And because of its focus on services, it can offer helpful insights related to wage and salary inflation in these areas.
To this point, Uncle Sam reported supercore CPI up 0.85% in January compared with December 2023. Very telling. That's about 10% annualized, way above the Federal Reserve and other central banks' 2% annual inflation target.
This only supports what we said yesterday, that if you believe Powell when he says the central bank is looking for "more good data" before it calls for rate cuts, yesterday's data wasn't it.
All the best,
Corey McLaughlin
Baltimore, Maryland
February 14, 2024