MarketSmith powers the charts in this video.
Bull markets climb a wall of worry. The most recent threat is the resumption of interest rate increases. The 10-year yield is back above 4% and extremely close to making new year-to-date highs. Rising rates mean rising inflation expectations. If yields continue to perk up, the whole rally might crumble under their weight.
Ever since stocks topped in October of 2021, the Nasdaq 100 (QQQ) has been highly correlated to Treasuries. When interest rates went up, QQQ went down and vice versa. This relationship continues up until April of this year when all of a sudden we saw a big divergence. Rates remained relatively subdued while QQQ skyrocketed. Now that rates are rising steadily again, QQQ is starting to feel some pressure. Rates are the single biggest factors that can define the destiny of stock prices in the long-term and they might foreshadow further yield increases by the Fed.
The other major force that has a significant impact on stocks is earnings. The next earnings season starts on Friday with a few banks reporting. Most stocks have gone up substantially higher between last and this quarter. This usually means that high expectations have been priced in and they will be hard to exceed. As always, what truly matters during earnings is the market reaction to them. In the past couple of quarters, we saw plenty of companies that missed earnings estimates and reported negative growth. It didn’t matter. Their stocks still went up. In fact, this was the single biggest and the most forward-looking factor that predicted that inflation will gradually fall. Now, it remains to see how the market will react to earnings this quarter. If we see most companies that beat estimates and then gap up and follow through higher, this bull market is likely to continue. If all of a sudden stocks start selling off despite beating earnings estimates, the correction might be just around the corner.
There’s currently no evidence that this bull market is over. It’s true that breakouts had issues following through last week and we saw a lot of fading. It’s also true that the dips in strong stocks continue to lead to great buying opportunities. We are currently in the consolidation phase as a big run. I call it range-bound trading. In this environment, one has to be very nimble when trading breakouts and take profits quickly and often. Focusing on a pullback to 20 or 50-day moving averages is likely to offer a lot better risk -to-reward especially for swing trades.
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