Long-term yields drive a potential risk-on phase

After a rapid decline that began at the end of October, the S&P 500 index has made a surprising recovery in the last five sessions, returning to the same levels, and regaining the position a little above its 50-day moving average. This movement is not random but is surrounded in the short term by a series of indicators and macro data that are currently favorable.

Looking at the graph below, we can see that the engine that lately influences the bullish and bearish movements within the equity curve of the S&P500 index is that of the yield on the 10-year Treasury. In fact, we can see that the movements are negatively correlated (as yield rise, in the bottom box, the stock index, which is in the top box, drops - and vice versa).

The violent rise in yields which started around October 10th at the level of 4.5% then dragged the stock index downwards. Having reached the resistance, especially psychological, of 5%, the yield retreated, generating a bullish impulse wave on the stock index.

Studying better the positioning of the S&P 500 index, we can see that prices have reached the upper part of the short-term bearish channel (red dotted lines). The same channel is then contained within a medium-term bullish channel (blue dotted lines), where the price has recently returned.

Another interesting fact is that the price is in an area around the 4350/4400 range, where a congestion zone was created around mid-October which acts as a bit of resistance. The price movement in the coming weeks will therefore be crucial to understand whether there will be enough strength to overcome the area in question and therefore exit the short-term bearish channel.

If we look at the market breadth using the index that indicates the percentage of stocks above the 200-day moving average in the S&P 500 Index, we can see in the lower panel of the following graph, that we have had a strong reaction around the zone of 25%. It is a level which has also functioned as support on other occasions (but which however was followed by a subsequent lower low - see the areas with the blue circle), and is close to the important 10% area, reached from the market in extreme situations.

To have a continuation of this stock market short-term bullish trend, we need a temporary stabilization of the yield curve. It is possible (and I would even say healthy) that the price level of the stock index will also stabilize, perhaps with a temporary weakening followed by a subsequent recovery: the last bullish leg presents some gaps between the hourly candles, i.e. there are some price gaps between one candle and another due to the rapid rise: there are two "holes" around 4,260 and 4,340. Typically, the price “comes back” towards the gap levels to “close” them. It is not a rule to follow, but a point of attention. As an example, I report a graph of the S&P 500 index with daily candles since the beginning of June. The green areas indicate the closing of the gap made by prices in the following period. The red ones on the other hand, the failure to close. You can clearly see that we are at a 5 to 1 ratio between closures and non-closures of the gap. And in the last week, we have two new gaps (it is likely that, depending on the platform you use, the gap data do not always coincide. The two levels I previously indicated are those of the futures listed on the CME - for an analysis for short-term trends I suggest you look at the posts published daily on our site by James D. Touati - the “Wolf of Zurich”). The important thing, however, is the holding of the last minimum around 4100.

However, everything is linked to the trend of yields which have a support zone at 4.5% and the following at 4.35%. The macro data relating to the slowdown in American employment growth on Friday was also an excellent catalyst for this movement, as it suggests a more accommodating policy on the part of FED.

If we look at the curves of the main bond futures (US Treasuries, German Bund, French OAT and Italian BTP), we can see that prices have exceeded the upper Bollinger band, the 50-day moving average, and the previous high of mid-October. The RSI oscillator is above 50 and is approaching the overbought level. The MACD, apart from the American market, has crossed the zero line. But it is all still very embryonic as we can see that a much bigger attempt was made in the fourth quarter of 2022 (see the periods indicated in the ellipses), but the trend continued downwards.

A difference that catches the eye, compared to the yield rise in the last quarter of 2022, can be seen on the graphs with longer time horizons: on the monthly 10-year Treasury graph we notice that prices are approaching an important support area which corresponds to the two minimums of the 2006/2007 period. The oscillators are in divergence with the prices (i.e., the oscillator during the period examined has an opposite direction to the price trend), and this indicates a slowdown in the prices. It is difficult to consider a very important reversal at the moment, given that the divergence occurs in a bearish market, but in any case, it is a signal not to be underestimated.

Even on the 30-year Treasury prices we have a divergence, which in the period in which the market was bullish, always anticipated a medium-term inversion of the price curve (see the inversions linked to the MACD divergences indicated with green arrows). It is not certain that the same considerations apply in a bearish market, even if we may have a certain reaction (perhaps a phase of lateralization and/or consolidation).

In summary, indicators and macro data suggest that the stock market could enter favorable year-end seasonality and provide some relief to investors. At the moment, however, the situation is very embryonic and therefore a certain caution is necessary. We may have further confirmation of the trend in the coming weeks, always keeping an eye glued to the Yield curves.

About the author

Mario Valentino Guffanti is a board member and Head of the Lugano Chapter. He is a financial advisor, technical analyst and researcher based in Milan, Italy. As an author of technical articles and lecturer as well as instructor in technical analysis courses in Switzerland, he is also dedicated to financial coaching through NLP techniques (neuro-linguistic programming).