The latest selloff in stocks and bonds may be signaling the end of one of the best trades of the COVID era.
The TINA (there is no alternative) trade has been a reliable support for equities, with the buy-the-dip crowd always willing to come in to help the major averages. But the surge in bond yields and projections for the fed funds rate are giving investors option.
That's not to say that buy-the-dip is gone. While the Dow (INDU) (DIA) fell to its lows for the year, the S&P 500 (SP500) (NYSEARCA:SPY) bounced right off the June lows and the Nasdaq 100 (NDX) (QQQ) and Nasdaq Composite (COMP.IND) are also holding above the nadir of the year.
But now investors have an alternative. The 2-year Treasury yield (US2Y) (SHY) can give investors a 4.2% return compared with the S&P's dividend yield (SPYD) of around 1.7%. The fed funds rate is projected in the latest FOMC dot plot to hit 4.4% by the end of this year. So, money market funds will finally be an alternative again. Cash could also rotate into bond funds if investors think the fixed-income selloff is reaching the end.
And it's not a good outlook for stocks.
"The combination of the S&P 500’s bearish trend and poor seasonals suggests trading conditions are likely to get worse before they get better," Oppenheimer technical analyst Ari Wald wrote. While "we see an opportunity for the long-term investor, we caution that extreme pessimism can linger over the near term. For the S&P 500, we see near-term downside risk to 3,500 which would mark a 50% bull market retracement."
Where to look: Goldman Sachs slashed its S&P (SPY) target to 3,600 last week. The equity team recommends defensive positioning amid uncertainty. With surging rates short duration will outperform long duration and investors should own stocks with "quality" characteristics like strong balance sheets, stable sales growth and high returns on capital.
BofA's Bull Bear Indicator hit max bearish at 0 again. But with housing close to traditionally recession levels they spy "diamonds in the rough" in stocks and credit absent a "financial event": SPDR Homebuilders (XHB), Russell 2000 (RTY), Philadelphia Semiconductor (SOX), emerging markets (VWO) (EEM), investment grade bonds (LQD) and high-yield bonds (HYG).
In bonds, MKM says (TLT) is down "nearly 32% from its level late last year."
"Some of this was a necessary adjustment as rates were too low and very out of whack with the business cycle last year. What a difference nine months makes: we now have a 4.6% peak Fed funds rate priced into the market (the expectation was for only 75 bps of rate hikes during 2022 at the end of last year), the 10-year Treasury yield has more than doubled (TBT) (TLT), and inflation expectations have been cut by one-third (from their March highs)."
See the events that are going to move the market this week.