Time to Rebalance? — Evening Brief – 07.03.24
U.S. stocks have displayed remarkable resilience since establishing a multi-month low in October 2023. If history is any guide the first half of July will only add to the bullish optimism as it has been the best two-week period for equities since 1929. At that point, however, will it be time to take some chips off the table and rotate into other assets? The argument for tempering expectations for U.S. equities appears compelling and can be argued that the groundwork has been laid for a period of rebalancing.
A good way to assess current conditions is with a study of technical analysis. While there are numerous indicators that suggest the market is “frothy” and due for a correction, we highlight two of them. For example, across all major indices, the percentage of stocks above their 200-day moving average is nearly 53% – off its high of approximately 68% in late December 2023, but more than double its lows of around 23% at the October 2023 low.
Furthermore, analyzing the Advance-Decline (AD) line of the S&P 500, which measures the breadth of the market, has been diverging from the S&P 500 since May, even as the index posts record highs. The negative divergence between the A/D line and the index indicates that the increase in a small number of prominent stocks, such as NVDA, has perhaps concealed a decline in overall market sentiment.
The divergence further amplifies the market’s concentration risk given that the index is market-weighted with the largest companies holding the lion’s share, while underperforming stocks are losing weight. A significant decrease in the value of the largest companies’ shares will have a disproportionately large effect on the overall index.
Meanwhile, the notion that the uptrend in U.S. Treasury yields has peaked is garnering increased attention. Pull up a chart of the performance of U.S. stocks and Treasuries over the past three years using the SPDR S&P 500 ETF (SPY) for stocks and iShares 7-10 Year Treasury Bond ETF (IEF) for government bonds. The divergence is glaring.
“We’ve seen the peak in yields,” said Stephen Miller, an investment strategist at GSFM. “Bonds are now back as having a deserved place in a multi-asset portfolio.”
While it may be premature to fully embrace the idea of a peak in U.S. Treasury yields, it is possible that we are currently experiencing the initial phases of it. From some of the indicators noted above, the odds are starting to favor rebalancing. The argument is particularly convincing for portfolios that have bond holdings significantly higher than their target weights.