Reflex Rally

Quite the market reaction this week as both stock and bond prices rose from oversold levels as three months of decline may have come to a conclusion. The Fed decided to hold off on rate increases this week and did warn of persistent inflation becoming a problem but the market interpreted this as the end to a rate cycle.

Additionally, the weak jobs report on Friday fueled this narrative and the Fed Funds futures showed the market is back to expecting rate cuts by June of 2024. Case in point, rate cuts after a yield curve inversion are typically followed by a recession and a fall in stock prices.

Chart Time

Was the Fed decision and payroll report the reason yields fell this week? If we review the chart of the 10Yr Treasury bond we can see yields were due for a reversal as they have risen substantially over the summer. According to this chart, a pullback to 4% is not out of the question but the long-term trend warns of higher yields next year. If true, it may give the stock market reason to rally in the near-term but the bond market still has to contend with the deficit, debt ceiling, and sticky inflation. Of course, bond yields may also be declining due to a slowing economy so keep that in the back of your mind when you read the headlines about a goldilocks scenario.

The S&P 500

Two charts in this section. The first one below shows a ‘weekly’ chart (2020 to present) where each bar represents one week of price action. As you can see, momentum since mid-July has been to the downside and we are nearing two years since the last all-time high in January of 2022. The last green bar on the right represents the price action this week and you can see the magnitude of the rise in only one week.

However, if you zoom into the short-term chart (September to present), you will see an overbought condition with several gaps in the chart. Many times, these gaps are filled within a week or two in this time frame and you can see we have three gaps in one week which is rare.

It is likely we begin to experience some pullback/consolidation in the next 1-2 weeks. If the 10/27 low can hold after a pullback then a case can be made for a sustained rally for several weeks, however, bear market rallies are notorious for vertical moves and this may be another one that is vulnerable to a reversal.

Paul J. McCarthy

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Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.