US stocks took a hit yesterday from the hotter-than-expected September CPI report , which saw headline prices jump and core annual inflation also push up to 2.6%. Tech shares were the ones bearing the brunt of the pain and with futures also pointing lower today, it is tempting to pin all the blame on inflation. The simple argument is that the last thing that investors want to see is the Fed reaching for another reason to keep rates “higher for longer”.
Having said that, the bond market reaction didn’t exactly play to the same tune. Treasury yields spiked higher on the data release but quickly gave it all back and are falling even lower today. 10-year yields are now down to 5.10%, its lowest in three weeks. And yet, stocks seem to be struggling still.
So, what gives?
If higher borrowing costs were supposed to be the main concern for equities, shouldn’t the pullback in yields offer some relief instead? Besides, the market pricing for the October Fed meeting hasn’t shifted all that much too. Traders are pricing in roughly 29% odds of a rate hike, just a mild step up from around 22% odds yesterday.
While hotter inflation certainly isn’t helping with market sentiment, it is not entirely convincing to say that the report yesterday tells the whole story behind the selling.
Let’s try to dig a little deeper, shall we? Perhaps the bigger problem is that the broader US stock market hasn’t actually been doing all that well for quite some time now, even if price action in the S&P 500 itself hasn’t been telling us that.
(h/t @ KobeissiLetter )
The chart above shows the 52-week correlation between the equal-weighted S&P 500 and the traditional cap-weighted index, with the figure falling to just roughly 0.67 earlier this week. That marks the lowest reading in the chart’s history. For some perspective, this figure stayed largely between 0.95 and 0.99 for nearly 15 years before the Covid pandemic. So, there’s definitely a remarkable divergence happening here in the past few years.
But the question is, what exactly does that signify?
The falling figure suggests that the performance of the biggest companies is now a much less accurate representation of what is happening to the average stock in the index. In other words, the S&P 500 is now becoming so top-heavy i.e. dominated by mega-cap names, that the headline index can easily disguise just how much weakness there is elsewhere in the market.
And if that’s not convincing enough, let’s take a look at the next chart.
This shows that only about 18% of S&P 500 stocks are trading above their 50-day moving average, while just 27% are holding above their 200-day moving average.
But if you look at it from the other angle, it signifies that more than 80% of the stocks in the index are trading below their short-term trend measure. And nearly three-quarters are below their long-term trend measure. Now, that is hardly a picture of a healthy market underneath the surface.
I’m not saying that this is enough evidence to necessarily point to the fact that a major market correction is coming. But when market participation is already this weak, it doesn’t take much for selling pressures to spread – especially if the heavyweight names (mostly big tech I would say) holding up the index start to falter as well.
As such, the hotter inflation numbers yesterday may have given Wall Street another reason to hit the sell button. But perhaps the fact that stocks are continuing to feel the pressure even as Treasury yields come off the boil is more to do with the market already looking quite vulnerable well before the inflation numbers landed.
This article was written by Justin Low at investinglive.com.
