As of yesterday the Standard & Poor’s 500 stock index had climbed 5.8% in the last five trading sessions. That recouped much of the 9.03% drop (not quite an official correction of 10% or more) from January 26 through February 8.
Which, of course, raises the question of what lies ahead–A rapid climb back through the old high of 2872.87 to new records (a classic V-recovery) or a move back to near the old high, followed by a failure at that level and a deeper correction of, say, 15%? (This would be a replay of the chart in 2015.)
I’m inclined to favor the latter possibility. The current recovery is based in large part, from my listening to Wall Street, on the market’s new-found belief that a yield of 3% on the 10-year Treasury (and all the higher interest rates up and down the yield curve that 3% represents) isn’t a problem for stocks. What I’ve heard this morning is Wall Street strategists, who just two-weeks ago were talking about 3% being a big negative for stocks, saying that stocks will do just fine at 3%. It’s 3.25% that markets need to watch out for is this morning’s wisdom. (The yield on the 10-year Treasury had retreated to 2.85% as of noon today, down five basis points from yesterday.)
Aside from the important question of exactly how different 3% is from 3.25% for decisions on capital spending, stock buybacks, and leverage, I would point out that 3.25% isn’t going to lag far behind 3% if we reach that 3% level. The inflation indicators that have been pushing up yields are still indicating strengthening inflation. The Trump budget on top of the December tax cuts and the February deal to blow out spending caps still adds up to a big stimulus to an economy that may be running near capacity. Consumer debt levels are still climbing and the savings rate is still falling. The U.S. Treasury is still looking at having to sell debt to cover an extra $1 trillion to $1.5 trillion in deficits over the next ten years.
Do you see a reason to believe the yield on the 10-year Treasury will stop at 3%?
And if it doesn’t, is today’s belief that 3% isn’t a problem but that 3.25% might be, anything but a recipe for correction sometime in 2018?
Of course, if that scenario is right it still leaves us with the teeny-tiny problem of figuring out when. My own scenario says that this rally does indeed take us back to the 2883 high–after all, it’s only 130 points from where the S&P 500 stood at noon New York time today. Then, looking at the Federal Reserve meeting on March 21, the market washes through a period of volatility without much net movement in one direction or another. The next correction arrives sometime after that meeting–my prior to watch would be after the next Fed meeting on May 2–when/if inflation indicators continue to point upward, when/if the Fed suggests that a May interest rate increase isn’t the end of the string for 2018, and when/if the yield on the 10-year threatens to move above 3%.
For the next few weeks let’s enjoy the recovery and recognize that this isn’t the time to put on big risk.