I thought the US stock market was overextended last week after the FOMC statement endorsed Wall Street’s “three rate cuts in 2H 2024 consensus”. My problem was this could be derailed by one bad inflation number and that Goldilocks economy might find that its growth porridge was a tad too hot. This is exactly what happened with this week’s data and thus equities were slammed last night while the yield on the 10 year US Treasury bond has risen to 4.38%. The Volatility Index has also risen from its complacent 13 and change levels a week ago to 15 now. This implies the path of least resistance for risk assets is now lower even as Brent crude flirts with $90. So let me voice the heresy. There is more money to be made in energy (the top index sector for 2024) in the next three months than Nvidia or Microsoft if bond yields and vols move higher to the 4.60% and 16-17 levels, as I expect.
True, a single secession swoon in New York does not a pullback make but the fact remains that the market’s spectacular rally has been so heavily skewed towards growth megacaps and darling sectors like AI, semiconductors and software. SocGen even estimates that AI alone has added 700 points to the S&P 500. So it is no surprise to see sector rotation into energy, financials and industrials at a time when the S&P 500 is unquestionably overvalued at 20.8X forward earnings. Any Fed angst, inflation scare or crude oil spikes can turn Wednesday bearish snowball into a 12-15% index avalanche. Don’t worry, be happy, could be the ultimate April Fools’ Day irony on Nasdaq.
After a spectacular 26% bull run in the S&P 500 since late October, there is compelling evidence of speculative froth on Wall Street and with 90% of S&P 500 Index stocks in an uptrend is obviously an overbought market. Even the merest hint of rising inflation, or a pullback in Fed interest rate expectations (the subliminal message of the chest pounding King Dollar in the past month to me) can and will derail the best laid plans of mice and men chasing high beta cheese in the market. Could this be a late 2021 déjà vu moment? In my risk/reward calculus, yes.
When seven Federal Reserve honchos/FOMC members, led by the Cleveland Fed’s Loretta Mester expect 3% inflation and Brent spikes to 90, it is insane to buy the 3 rate cut in 2024 Street group-think. A June FOMC rate cut is no longer a slam dunk and the bond vigilantes have begun to smell blood. So I recommend it is time to dial back on greed and embrace fear because there are times in capital markets when a man needs both his belt and his suspenders in place at the same time, with adult diapers as a safety option. Have we not learnt the hard way that heaven hath no fury than a woman or the bond market scorned? My call is that we see 4.6% to 4.7% on the 10 year US Treasury bond yield. Note the fairytale rise in Seven Sister colossus Exxon, 105 two weeks ago, 120 now. Oh Gas Gods! SLB had sunk to 47 after the Aramco news when I flagged it here. It is 54.7 now.
Also published on Medium.
