Closelook at US Stock Markets - Post 4

Valuation compression stage 2 of risk on assets has set in. The current market decline will end when the 10-year/20-year notes/bonds rise has reached a short-term/intermediate end. This may be around 4.5 % and would coincide with a real yield of 1.5 % (10Y minus CPI).

Remember: NASDAQ bottom coincided with the interest rate peak

NASDAQ bottomed in early November 2022, exactly when the 10-year notes recorded their top. Unless we have another round of unpleasant surprises from JP, we expect this to happen around the Jackson Hole FED meeting, which coincides with the August PCE print on 31 August.

Fundamental: One for the bulls and two for the bears

There are three scenarios for the US economy:
1. Economic growth stays strong, and inflation and rates fall (if inflation ticks down towards 2% in 2024, we won't need rates at or above 5%) - perfect for risk-on assets
2. Economic growth deteriorates (negative GDP growth plus recession), inflation falls, and rates fall - foul for risk-on assets at first as earnings go down while valuations go up
3. Economic growth stays strong, inflation stays sticky, and rates remain higher for longer - bad for equities as valuations go down while profits go up

In May / June / July, the market preferred scenario one as the base case. Inflation was coming down, and the economy was growing well. Scenario 1 is the soft landing camp. In August, sentiment shifted. The market is betting that scenarios 2 and 3's likelihood has increased. Scenario 2 is the recession one. Even though rates would be cut, the headwinds to business performance from a recession would overwhelm the rate tailwind.
Scenario 3 is the "economy is stable, but inflation stays sticky" scenario. The 10Y has risen to 4.3%, up from 3.4% in early May. This is the highest the 10Y has been since pre Global Financial Crisis.

The market is now discounting higher rates for longer and gets rid of the inverted yield curve in a bearish way (long-term rates rise faster than short-term ones).
This puts pressure on risk on equities. Profits have troughed and have started to grow slowly while an initial 0.5 % more in long-term yield reduces the multiples investors are willing to pay for, e.g., enterprise cloud stocks, by about 10 % (there is no fixed, linear relationship solely based on how rates and multiples behave, if rates continue to climb). But if, e.g., the 10Y goes from 3.75% to 5.25% and stays there - there would be quite a lot of downside pressure.

Technical: A test of the lower NASDAQ channel

We still see a test of the lower NASDAQ channel. If the market is weaker than expected, we may see a 38.2 or 50 percent retracement of the last move up.

Although our initial price target on the NASDAQ100 has been reached today (18 August), we are not currently entering long positions.

#nasdaq #nasdaq100 #sp500