The Week Behind

Although benign macro data allowed the major indices to record impressive weekly performances, the market still feels fragile as downward pressure from the US10Y yield persistently reminds investors that the Fed’s battle with inflation remains the dominant concern. The NASDAQ, S&P 500, and Dow closed the week approximately 3.25%, 2.50%, and 1.50% higher, respectively.

Highlights 

• Job openings printed significantly below expectations, implying disinflationary slack is generating in the labor market.
• ADP’s headline job creation missed expectations and reported multi-month lows in wage inflation.
• 2Q GDP was revised down to 2.1% from the initial 2.4% estimate.
• PCE provided a mixed read on inflation. Core PCE aligned with analyst forecasts, but headline PCE exceeded the prior month by 0.3%, and personal spending surpassed consensus by 0.1%.
• Despite headline job creation beating the forecast – 187k actual versus 170k estimate – Payrolls saw unemployment rise by 0.3% to 3.8%. The uptick signals the potential for a downward contribution to inflation from the wage component.
• The week closed with ISM and Construction Spending significantly outperforming expectations. This robust economic data triggered a rally in the US10Y yield, dampening the momentum generated by Payrolls.

Bullish Technical Signal

When the market appears directionless, the value of technical indicators increases. As of Friday’s close, the S&P 500 has officially confirmed a 5-13 day EMA bullish crossover. This signal indicates, at least in the short-term, that bulls have the edge over the bears. You can find a more comprehensive analysis of this indicator and its impact on the S&P 500 here.

Given the 5% peak-to-trough correction in the S&P 500 was met by a series of constructive inflation and earnings data, it’s logical that price has broken the way of the bulls in the short-term. However, in my opinion, for this momentum to continue, it is essential the US10Y yield remain below the ~4.35% cycle high.

The Week Ahead

After a busy two weeks, the first week of September offers a calm start to the final quarter of the year. The trading week, shortened due to Labor Day, begins Tuesday. Besides Wednesday’s release of the Beige Book, which investors will scan for labor market insights, there is not much in the way of corporate earnings and economic releases.

Traditionally, the first week of September signifies the conclusion of the “summer doldrums”, marked by a return to normal trading volume as institutional participants rejoin the market after their vacations and make year-end adjustments. The conviction of market movements typically correlates with the level of trading activity. Consequently, it’s often argued that the market may be less “efficient” or “reliable” during the doldrums due to reduced participation. As trading volume rebounds, the direction in which the market initially breaks, whether favoring the bulls or the bears, could set the tone with greater conviction than the somewhat indecisive tone experienced over the past few weeks.

In summary, while the upcoming week appears uneventful on surface, a normalization of trading volume could render it a pivotal week for market direction.

What is the US10Y Pricing?

In previous months, the US10Y yield had declined in response to reports indicating cooling inflation or labor market conditions. Therefore, the buoyancy of the US10Y yield, despite the same economic backdrop in August (refer to the “Highlights” section), is somewhat surprising.

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This leads to the question: what exactly is the US10Y yield pricing in?

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My best guess is that the US10Y yield is currently factoring in the “for longer” aspect of the Fed’s “higher for longer” mantra. Given the Fed’s focus on core metrics and the persistently elevated inflation levels within those core metrics, it’s plausible that the US10Y yield reflects the bond market’s consensus that the Fed will indeed maintain the short-end of the curve, the Fed Funds Rate, at higher levels for an extended period. While it’s possible that the bond market has not fully recognized the benign inflation readings released during the “summer doldrums”, I consider this explanation less likely.

In any case, a resilient US10Y yield seems to be the primary hurdle for stocks at this time. If you are putting money to work in the near term, use the US10Y yield tactically: Remain skeptical of a rally without a retreat in yields. Avoid buying a dip in stocks until rising yields show signs of stabilizing or declining.