Control Panel: Trend change, two-speed economy

Big Stocks Won When Markets Rose. They Are Winning Again in the Selloff.

High rates and war fears hit smaller stocks harder—driving an unusual split in two of the major U.S. indexes


James Mackintosh, The Wall Street Journal, April 21, 2024

One of the biggest concerns amid the run-up in stocks in the first three months of the year was that the rally was dominated by the biggest companies. As it sold off this month, the market became even more top heavy. …

The impact of higher rates is part of the two-speed economy that has resulted from sharp rate rises, and then this year the evaporation of hopes for multiple rate cuts. Big companies are insulated from the impact of higher rates because they used their easy access to bond markets to lock in superlow-cost debt for a long time when rates were low. Many of the very biggest, particularly Big Tech stocks, are also sitting on huge piles of cash, which are earning more thanks to rate rises…

By contrast, smaller firms find it hard to issue bonds and borrow far more at a floating rate. As with poorer consumers who borrow on their credit cards, the cost of this debt has soared as the Fed tightened, hitting the profits of smaller companies… [end quote]

It isn’t often that I declare a trend change.

After a long run of sunny METARs, last week the METAR changed to overcast with some rain.

I noted that the NASDAQ 100 Bullish Percent had been trending downward although the NASDAQ index had been rising. I had a bad feeling about this and sold my shares of QQQ. Just in time.

Last week, the stock indexes dropped in response the Federal Reserve’s announcement that a strong economy and stubborn inflation would keep them from cutting the fed funds rate. The options market doesn’t predict a fed funds cut until September. At the beginning of 2024 they were predicting 6 cuts. This is the third time that the market has dropped in disappointment at a delay in the Fed cutting the fed funds rate.

At the same time the entire Treasury yield curve shifted upward. Far from the negative slope seen in late 2023, the Treasury yield curve is now close to flat. Not because the Fed dropped the overnight rate but because the market is demanding higher yields for the longer durations.

The last time this happened – July to November 2023 – the stock market fell for months. It’s impossible to say whether the past week was noise but it feels like the start of a bear market move. Since the market is in a bubble it’s also possible that the bubble will burst causing a real bear market.

There is no sign of a financial crisis (yet). Although VIX jumped it’s still within a normal range. Financial stress is very low. It’s possible to have a bear market without a financial crisis – that’s the norm which has happened many times. The Fed will only step in with QE in a true crisis as they did in 2008 and 2020. (And in a small way in March 2023 with the collapse of Silicon Valley Bank.)

The Fear & Greed Index has dropped into Fear after many weeks in Greed. The trade is mildly risk-off. USD, gold, silver and copper are rising. Oil dropped slightly and natgas is stable.

The METAR for next week is rainy. Since this trend is only a week old it may be noise. It’s hard to tell whether it will blow up into a storm at this point. Investing into the peak of a bubble is always dangerous whether the bubble is stocks, railroads or tulips. (cf. the books, “Manias, Panics and Crashes” and "This Time is Different.)