Spilled Milk and Santa Claus. It’s not About the Fed. It’s About the Bond Market.

November 17, 2024

There is a lot of crying over spilled milk on Wall Street these days as bond traders are not happy campers.  And yes, bond yields make the trend in the stock market.  Meanwhile, Santa Claus seems to have pulled the sled back into the garage for now.  But, as I describe below, the New York Stock Exchange Advance Decline line (NYAD), despite its ominous appearance, may be closing in on an oversold level, from which we may get that yearend rally.

As I noted here last week, the potential for a hotter than expected CPI could well upset the proverbial stock market apple cart.  And so, it was. With CPI showing that inflation is at best slowing its rate of ascent, bond yields resumed their climb and Fed Chair Powell finally admitted that inflation isn’t going away, at least at the moment.

Still, for investors it’s best to focus on the bond market’s response to what the Fed says or does.  That’s because bond traders are more in tune with inflation than the Fed. Instead of focusing on statistics and models, a bond trader’s response to inflation reflects how much the return on their is money being eroded by rising prices.

For example, the October CPI said that inflation rose 2.6% year over year on top of the cumulative 20% it’s already risen by some measures since the pandemic, that’s an additional 2.6% reduction on their return over the past twelve months.  If that keeps up for another five years, bonds bought in 2020 have the potential to face a 33% reduction in real returns.  That’s a loss of one-third over fourteen years.

For stocks, rising bond yields signal a decrease in liquidity in the financial system, by increasing the amount of money which is required for debt servicing.  Lower liquidity triggers sell programs tied to rising bond yields worsening the market’s liquidity and driving stock prices down.   

There are two ways to increase liquidity. One is for inflationary conditions to improve, which often comes with a recession.  Lower inflation reduces the amount of money required to service debt and increases liquidity.  

The next jobs number is likely to give us clues about whether companies are increasing layoffs, which is often a harbinger of a recession.  GM just announced 1000 job cuts while Advance Auto Parts (AAP) announced it will close 700 stores.  This is in addition other layoff announcements including Stellantis (STLA).  Here is a summary of recent layoffs.

The other way is for the Fed to start QE in order to stimulate the economy.  This may not happen in the short term.  But if the economy craters rapidly, it’s coming.

Ten Year Note Struggles to Rise Above 4.5%. Yet 4% is Still a Tough Lower Limit.

As I recently noted, bond traders are looking for a reason to buy. Yet, their enthusiasm seems to be limited to short bursts of nibbling.  As a result, the U.S. Ten Year Note Yield (TNX) is still stuck between 4 and 4.5%. In fact, little has changed since October as TNX has risen despite being persistently overbought (RSI near 70) while often tagging the upper Bollinger Band, and avoiding a return to its 20-day moving average.  The bullish side of this situation is that the longer it lasts, the more will the chances of a reversal increase.

Mortgage rates are also looking to top out but remain near their recent highs, as they are tied to TNX.   Get more details on this topic here.  If you’re not getting my FREE weekly real estate and interest rate updates, you can sign up here.

Bitcoin Goes Parabolic. A Pause that Refreshes is Overdue.

Bitcoin (BTC/USD) certainly did not disappoint longer term HODLERs with its nearly pyrotechnic display over the last few days.  But it has come a long way in a short period of time and is due for a pause. The thing is that money keeps pouring into the Bitcoin ETFs, which means that there could still be more upside.  In the short term, though, a consolidation would be welcome.

Bitcoin is clearly overbought with the RSI trading well over 70 for the past few days, while both the ADI and OBV lines have stopped their ascent.  So, if you’ve missed this rally, give it a bit of time to refresh. But until proven otherwise, this should remain an interesting asset over the next few months.  I’ve recently added two Bitcoin related trades, which have done quite well.

Homebuilders Trade to the Bond Market’s Tune.  Trading Tightens. Big Move Nears.

I’ve recently recommended adding homebuilders to long term portfolios.  I want to emphasize this is a long term trade which is likely to require some patience to pay off.  That’s because if you watch the interaction between homebuilder shares with bond yields, it’s uncanny to see how rising bond yields trigger selling in homebuilder shares and vice versa.  That suggests that the success of this trade depends on the action in the bond market.

Yet, as I noted above, bond yields are struggling to rise above 4.5.  Thus, any investor with a long term time horizon can use instances where TNX tags the 4.5% yield and reverse, to add to long term homebuilder positions.  On the other hand, if bond yields rise above 4.5%, this would signal that it’s a good time to hold off on adding to positions.  Just remember, the following bullish scenario, supply and demand favor the homebuilders. 

The iShares Home Construction ETF (ITB) remains range bound tied to the action in TNX.  A fall to the 200-day moving average is still possible.  On the other hand, the Bollinger Bands are getting tight around prices, which suggests a big move is coming. The ADI line is falling (active short sellers) while the OBV line is holding up (value players nibbling).  We may be in for a short squeeze. Stay tuned.

If you’re an ETF trader, consider, Joe Duarte’s Sector Selector.  It’s FREE with your monthly membership to Buy Me a Coffee.  Sign up here.  If you’ve been thinking about starting a day trading career, my new book “Day Trading 101” will get you started on the right foot.  For short term intermediate momentum, and frequent option trades, visit the Smart Money Passport.

NYAD Signals Possible Trouble Ahead

The New York Stock Exchange Advance Decline line (NYAD) rolled over and is once again testing its 50-day moving average while the major indexes swelled to new highs. On the plus side, the RSI is now below 50 and making its way to an oversold reading of 30, from where the next rally is likely to start, just in time for the potentially bullish year end run.

The Nasdaq 100 Index (NDX) made a new high a few days ago, but on 11/15/24 it rolled over aggressively.  20,000-20,500 (50-day M.A. and large VBP bar) are still a key support area.

The S&P 500 (SPX) briefly tagged 6000 before a nasty reversal to the 20-day moving average.  The 50-day moving average is support near 5700.

VIX Holds Below 20

The CBOE Volatility Index (VIX), is remained below 20 which is a bit of a positive divergence given the recent reversal in stocks.

VIX rises when traders buy large volumes of put options.  Rising put option volume leads market makers to sell stock index futures to hedge their risk and leads markets lower.  A fall in VIX is bullish signaling lower put option volume, eventually leads to call buying which is bullish as it causes market makers to buy stock index futures raising the odds of higher stock prices.

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Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com - now in its third edition, The Everything Investing in your 20s and 30s and six other trading books.

Meanwhile, the U.S. Ten Year note yield (TNX) is trading in a The Everything Investing in your 20s & 30s at Amazon and The Everything Investing in your 20s & 30s at Barnes and Noble.

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