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Stock markets have been in free-fall for almost the entire trading week. Such movement in the current situation should come as no surprise to anyone. The value of many assets rose to historic highs. Rising US government bond yields forced investors to revalue assets, which led to a global sell-off in equities. Will this move be a local correction or is it the beginning of a global trend?
S&P500
By now everyone realises that the 10-year bond yield of 1.5% has approached the level of the average dividend yield of the S&P500 index, which at this stage is 1.46%. In such a situation it is more interesting to keep money in risk-free bonds than in US equities. The next negative factor for the stock market decline is the excessive pumping of it with cheap dollars. The average stock in the S&P500 index is now worth 20 times the expected 12-month yield of that security. This is a very large ratio, which indicates that a company’s assets are overvalued.
If bond yields continue to rise, it could lead to an avalanche of asset movements from equities to bonds. The critical level for 10-year bond yields is in the region of 1.8%, which could represent a serious risk for the stock market and the economy as a whole.
The US Federal Reserve, which is buying up treasuries, will come out on top in this situation in any case. At this stage, all statements of the Reserve managers are that the observed capital movements in the markets and inflationary effects are temporary, so no further adjustment is required. In any case, if bond yields rise obscenely, the US Fed can adjust its treasury plans at any time.
But there are a few positives in favour of the stock market. The first is the still-remaining problems with COVID-19. Although vaccination is ongoing, the increase in the disease is not dropping due to the prolonged winter in the USA. The second is the technical picture. The difference between the short and long positions on bonds from CTA (Commodity Trading Advisors), more simply the opinion of advisers on buying or selling trading assets, is placed at 85%. This means that this has been the case in the markets only 15% of the time since 2009, which is a clear signal for a possible correction in bond yields.
As a result, we can say that the current stock market movement looks more like a local correction than a trend change, but still it would be a good idea to keep a close eye on bond yields. In the next few weeks there will be another meeting of the US Federal Reserve which is likely to clarify the situation regarding interest rates and further plans to stimulate the economy. After the Fed’s plans it will be possible to shape the course for the next few months with more precision.
What’s in store for us today?
02.45 China manufacturing activity index for February from Caixin
9.55 German PMI for February
15.00 USA FOMC member Williams speech
16.00 US ISM Manufacturing Index for February
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