Evening Brief – 09.20.23
A Multiweek Pullback
The yield on the 10-year US Treasury note has risen from 3.25% in the spring to 4.35% as of Tuesday. However, the equity markets have largely ignored this trend in rising bond yields. Naturally, there was the artificial intelligence (AI) frenzy, which may not be a large contributor to earnings in 2023 or 2024, which is what the equity price movement for this year should be discounting.
Right now, it would be good to concentrate on quarter-end window dressing, favorable fourth-quarter seasonality, a near-certain pause on rate hikes by the FOMC on Wednesday, and what should be a rather strong third-quarter earnings season. However, the market dynamics suggest some prudence in the near term.
The demand for Treasury auctions is decreasing, oil prices are trading above $90 per barrel, the United Auto Workers strike indicates wide splits among union leaders and management, other central banks are still in an aggressive tightening campaign, and Congress appears to be on pace to bring about a government shutdown on October 1.
If the S&P 500 has climbed this high without significant growth in earnings and the avalanche of negative fundamental indicators mentioned above, and if interest rates are also rising, then the discounted value of future cash flows indicates equities should be lower. This is because rising interest rates are a sign that future cash flows will be less favorable to investors.
In addition, the US dollar has been steadily rising amid the favorable interest rate differentials between the US and other nations, which represents a possible one-two punch for the equity markets.
International companies dislike a strong dollar because it means reduced earnings when repatriated to the United States. While the S&P 500 index receives around 29% of its revenue from abroad, the technology sector, which has been a leader in 2023, receives 59%. As a result, higher yields discount future cash flows at a lower level, while a rising dollar decreases profitability.
We don’t need to enter a recession to observe a typical correction, which presently appears to be back to the 200-day moving average, which is rising and is just below 4,200 in the S&P 500.
Aside from the favorable technical backdrop, there is an overlapping and extremely important trendline connecting the pivotal lows in October 2022 and March 2023, which might be a suitable target for a pullback in equities in coming weeks.