Possible Relief Rally
October 30, 2023
The lack of a broadening Middle East conflict and oversold conditions drive today’s bounce in equity markets. Some are quick to point to a possible relief rally, though major indices are off best levels following negative pre-open reports (ON/RVTY) and a resumed backup in bond yields into tomorrow’s (tonight for US readers) BOJ meeting. There are rising concerns the BOJ will increase its inflation forecast with a 50/50 chance that it raises the upper band of its Yield Curve Control (YCC) policy. For US markets, an increase of the YCC band would lead to repatriation of money into Japanese markets, which would reduce a source of demand for Treasuries resulting in higher yields
The S&P 500 (SPX) and Nasdaq 100 (NDX) entered correction territory 6 weeks after we issued a tactically bearish outlook. The Russell 2000 (RTY) is also less than 2% away from being in a bear market. The RTY was the first US equity index to develop a bearish distribution pattern in early August and the first to break technical support. The RTY is a cyclical index and its weakness likely precedes a slowdown in US economic activity. Cyclical indices like the RTY, equal weight S&P 500 (SPW) and EuroStoxx 50 (SX5E) tend to lead broad indices and its no surprise that the SPX has recently broken key technical support at 4200.
Relief? The move into correction territory occurred as 10-year yields increased from 3.95% to 4.90% and the MOVE Index (bond market volatility) increased from 111 to 130. Rising bond market volatility has just barely spilled into the stock market with the VIX increasing from 13.63 to 21.27. The SPX is now oversold and a possible relief rally depends on a pullback in bond yields. There’s no shortage of catalysts this week that could provide a pullback in yields including tonight’s BOJ meeting, Wednesday’s Treasury refunding and Wednesday’s Fed meeting. Today’s rebound in US equities reflects some catalyst anticipation.
The NDX is trading below its Spring/Summer range lows and threatening to break lower, while the NYSE FANG+ Index (NYFANG) clings to support near 7175. The NYFANG closed below 7175 last Thursday, but quickly recovered on Friday and is higher again this morning. We remained concerned that an eventual break in the NYFANG could lead to accelerated downside momentum in the broad indices. Investor crowding into the largest stocks by market cap is a defensive dynamic that occurs at the end of a cycle, and crowding in NYFANG constituents is now at record extremes.