I have been consistent in saying that as long as the four pillars of the rally (Historic Fed accommodation, massive government stimulus, COVID vaccine optimism and no double-dip recession) remain in place, the trend in stocks is higher and any pullback should be viewed as an opportunity to add cyclical and value exposure, and while I still believe that is the case (and are not reducing equity exposure) the truth is that one of those pillars got cracked last week and as such we need to brace for the possibility of a near-term “air pocket” in stocks.
The pillar I am referring to is the Historic Fed accommodation, because after a full year of the Fed doing whatever it takes to support asset markets, suddenly Fed Chair Powell is uncharacteristically non-committal on the Fed pledging not to let a rapid rise in longer-dated bond yields derail the rally or the recovery. In short, over the past three weeks, culminating in last week’s WSJ Q&A, the Fed has allowed some doubts to creep into investors’ minds about their commitment to stimulus, and that's why stocks were volatile last week.
To catch up on the four pillars of the rally, read my previous post here
Positively, this “crack” in the pillar of this rally can be fixed, and as such it’s not fatal to the rally—although as we’ve been saying since yields started to rise in earnest six weeks ago, we all need to prepare for a more volatile ride in equities. To fix this crack in the pillar of the rally, the Fed (and ideally in concert with the ECB, BOE and BOJ) simply need to reassure markets that they will use the tools they have (extending the maturity of QE purchases or Operation Twist) to ensure that the rise in global bond yields doesn’t happen too quickly. Put differently, the Fed needs to better communicate that there is nothing wrong with a 1.60% 10-year Treasury yield, or even 1.75% or 2.00%, as long as the economy is growing, and the 10-year yield reaches those levels over time. The problem is if we continue to see the 10-year yield rising by 20 and 30 basis points each week. And until the Fed specifically reassures the market it won’t tolerate that much longer, we can expect upward pressure on yields and downward pressure on stocks, especially in tech/momentum/growth stocks.
The market has become more vulnerable, in part because of a Fed communication error, and we should expect more volatility and even a pullback until that communication error is fixed (and it almost certainly will be, it’s just a question of when). And to be clear, Friday’s rally was not Fed induced. It came because the 10-year yield couldn’t hold above 1.60%, and as the yield fell, stock investors chased markets higher. Friday didn’t fix the Fed communication issue, so that’s still with us as we start a new week.
But until we lose more confidence in the Fed or that pillar of the rally is destroyed, we will continue to view any material pullback of 10%-20% as a buying opportunity in value/cyclical shares.
Currently none of my short-term or long-term technical indicators are signaling risk-off and the S&P 500 remains bullish over the long-term. I fully expect volatility to continue.
Please reach out if you have any questions or concerns.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
8400 Normandale Lake Blvd, Bloomington, MN 55437