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Bigger Things Are In Motion
Yesterday we saw the S&P 500 make the biggest reversal from high to low since 1978. Despite the extreme oversold conditions, the major indices so far, could only muster one green day. Extreme weakness.
We must monitor carefully how the major indices react at the recent lows and highs
Bonds, Yields And Stocks
Bonds and stocks usually have an inverse relationship. Typically the 10-year US Treasury bonds reflect investor sentiment and economic expectations. It is partly a flight-to-safety asset. When the stock market normally declines, the 10-year US treasury bonds increases. Money flows from stocks to bonds.
As you can see, this does not always happen, the relationship is not completely linear. Bonds as well as the stock market can decrease together. But in the beginning of the decline, we saw a normal pattern, declining stock market and rising bonds. We are now seeing the biggest dumping of bonds since COVID.
Yields Have An Inverse Relationship To Bonds
When bonds dump the yield on the bond increases. The TNX reflects the yield on the 10-Year Treasury bonds. Yesterday it surged to almost 4.5%.
High yields is a problem since they impact and reflect the broader economic picture influencing:
Mortgage rates - high mortgages rates can impact consumer spending - recessionary
Higher borrowing costs reducing business investment
May be a signal of inflationary concerns
May be a signal of reduced overall economic growth expectations
Signal Of Major Shift In Sentiment Or The Basis Trade?
The basis trade is a hedge fund arbitrage strategy that leads to a big selloff in treasury bonds. This may have contributed to the selloff in bonds and the subsequent rise in yields. But there are concerns that this might be a bigger shift in investor sentiment.
Fleeing from flight-to-safety assets like treasure bonds may be an indication of very bearish outlook.
International investor confidence in the US might have shifted due to tariffs, leading to continued major selloff in US treasury bonds - spiking yields.
We Have Gone Through The Stairs Of Risk Aversion
Investors first rotate to defensive stocks and stable business, which we saw during March
The next step is fleeing to US. Treasure bonds which we also saw initially
Further risk aversion may lead to continued cash raising and commodity flight
Gold Likely To Continue Outperform
Probably a good position trade at the lows of the longterm channel floor
We Seldom Crash Straight Down
Like we saw yesterday, smart money unloads stocks in a smart way at highs of bullish reactions. This is how distribution works. It is therefore probable, as long as we don’t get a sudden financial and liquidity crisis, that we will continue oscillating up and down. Price action will help us interpret the direction going forward, and it is more important than ever to focus on the overall trend.
Risk First
I am sorry to nag about this, but it is important to understand that we should not buy in the unknown and hope for the best. Let the market prove itself before we dive in. It is much harder to regain a big loss, than to make a profit in a better market. Lets align the odds in our favor. Nobody knows where we are heading, lets follow price and continue navigate through all the clues together.
Hope this helps and thank you for reading. If you like the content feel free to share it.
Charts courtesy of TrendSpider
Disclaimer:The Setup Factory is not licensed to give any investment advice. The content provided in this email and from this Substack-account is my own thoughts and ideas about the stock market. It is for educational purposes only and should not be considered as any form of investment advice. Do not invest in any stock based solely on the information provided here. Trading stocks is highly speculative and involves a high degree of risk of loss. You could lose some or all of your money. You should conduct your own research and due diligence in any investment you do, to verify any information provided.