@theMarket: Bond Yields Up, Stocks Down

The seasonal influence of what is normally a weaker August through September continued this week. All the averages have declined since the end of July and will continue to do so in the weeks ahead.

 

My expected pullback in the equity averages continued this week. So far in August, the S&P 500 Index is down 5 percent, the NASDAQ has fallen 7 percent-plus, while the Dow Jones industrials outperformed with a 2.4 percent decline. There are several reasons investors could point to in explaining the pullback, but for me the reasoning is simple.

 

All the markets were extended beyond reason after a great first half of the year. The prices of the Magnificent Seven group of stocks were the worst offenders. To me, they were begging for a stiff bout of profit-taking. Add that to a seasonally weak time of the year in the markets and it was not hard to predict a sell-off.

 

Fundamentally, there is also a reason for concern. For more than two months or so, I have been warning readers that the U.S. Treasury was going to auction more than a trillion dollars of bills and bonds. That would, in my opinion, pressure yields on Treasury bonds higher and that is exactly what has occurred.

 

The benchmark, U.S. 10-year Treasury bond was above 4.31 percent on Thursday, which was its highest yield since 2008.  This threatens steeper borrowing costs. There is a heightened concern that if this trend continues it could whack the equity, debt, and housing markets. A lot of bond vigilantes were expecting yields to drop, not rise. Some of these traders have been forced to unwind their long positions on bonds, which is causing yields to rise even further.

 

China has also been a big concern this week. The world's second-largest economy has been rolling over for months. The legacy of a COVID zero-tolerance policy, harsh regulatory restrictions on the nation's largest companies, overbuilding in the Chinese property sector, and a plunging currency are some of the reasons for this situation. The fault largely lies with the policies of China's leadership, specifically President-for-life, Xi Jinping.

 

And while some of us may applaud China's economic comeuppance, the facts are that when China catches a cold, most of the rest of the world develops a bad flu, as do their stock markets. China's top three trading partners are the group of ASEAN nations, followed by Europe. The U.S. is in the number three spot. Slowing growth in China means slowing profits for a wide spectrum of countries and companies throughout the world and the U.S. is not immune to this development.

 

The Jackson Hole Economic Symposium will be held next week (Aug. 24-26). Fed Chairman Jerome Powell will be sharing his economic perception of the U.S. economy as well as the world. There is always the possibility that he could throw a curve ball that investors are not expecting. The bond market will be watching for any comments on interest rates and rising yields.

 

As I said last week, I am waiting for a short-term bounce-up in the markets, since we are getting close to my target of a 5-6 percent decline in the S&P 500. Right now, I am expecting yet another possible drop into mid-September if yields continue to climb higher.

 

If I am right and we do slide, how far could the decline take us? The 4,100-4,000 level on the S&P 500 Index is possible. If things really get unstrung a fall to 3,800 might happen but I am not really expecting that.    

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.