Equity market all-time highs should be welcomed not feared – Episode 118 of Damien’s Midweek Markets

The 118th episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about the potential for all-time equity market highs and why it can be a bullish sign.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 118

It’s been two weeks since the last show but the market’s narrative remains largely the same, a focus on inflation expectations and central bank monetary policy. There are still lingering concerns that the US and UK economic growth rates are reaching their peak, and that we could see a slowdown in economic growth coupled with high inflation (known as stagflation) that could impact equity markets.

On top of this rising numbers of the Delta variant cases are also starting to weigh on equity markets. These concerns are still best illustrated with the market’s obsessive following of the 10 year US treasury yield.

Last time I suggested that 10 US treasury yield remained an enigma to many with the consensus view that the yield should be much higher. We were in a position where either the bond market was too pessimistic or the equity too optimistic about the economic recovery in the US. Either way it means there could be some pain ahead for one of them.

Two week's ago the 10-year US treasury yield hit a low of 1.17% but it suddenly exploded higher to 1.375%. Don’t forget that when bond yields risel it means that the price of those bonds fall, which is also often to the benefit of equity markets. The S&P 500 broke convincingly above the key level of 4400 that I told you to keep an eye on, setting 4500 in investors' sights.

Looking beneath the index level and focusing on secor performance, we saw a familiar pattern, whereby reflation trade assets benefited, most notably financial stocks, at the expense of technology stocks. Whether the reflation trade can reignite depends on whether the 10 year US treasury yield continues to head higher.

In my newsletter to 80-20 Investor members last week, I pointed out that despite the consensus view that the 10 year US treasury yield would continue breaking higher, I highlighted that from a technical analysis perspective the downtrend in bond yields since May remained in tact. Coincidentally we then saw an abrupt collapse in the 10 year US treasury yield at the top of the downtrend channel I highlighted. Bond yields broke back down towards 1.2% hammering reflation trade beneficiaries such as financials along the way

The cause of the rush of demand for bonds was laid at the doors of rising Delta cases and weaker than expected economic data. We are once again back in the downtrend for bond yields, at least in the short term.

A break higher (above 1.36%) will be a boost for the reflation trade assets and cyclical sectors in the short term. A break lower should be more beneficial for growth stocks (such as tech) and REITs. If we do break lower, keep an eye on the 1.174% which is the recent low.

Ultimately in the last couple of weeks we have seen investors rotate in and out of assets and equity sectors based on the volatile day-to-day moves in the 10 year US treasury yield. There is a sense that investors are chasing their own tails in the absence of any guidance of central banks. The Bank of England and the US Federal Reserve aren’t scheduled to deliver their next monetary policy decisions until the end of September. That puts more of the focus on the Jackson Hole Economic Symposium next weekend. The event sees central bankers, academics and economists from around the world come together in Kansas to discuss economic issues, implications and policy options. A misplaced view or comment from a central banker could move markets, so beware.

However, if we ignore the day to day market moves and zoom out, bond yields are largely in downtrend, while key Western stock markets are still in an uptrend. Since my last show we’ve seen new all-time highs in the S&P 500, Dow Jones, FTSE 250 and the German DAX.

In all of these markets, we are starting to see tentative signs of improving breadth as well as sector rotations which are the lifeblood of a bull market. But there are many individual stocks that are hitting new 52 week lows akin to the slow motion correction we’ve seen in Japanese equities since February. Asian equities remain weak right now. But as my research for 80-20 Investor members has shown, new all-time highs in the major indices aren’t something to be feared, but something to be welcomed as they are a bullish sign. But that doesn’t mean the market can’t crash. Indeed the chances increase if we don’t see more and more stocks making new highs than are making new lows. improvement in breadth.