Rising Treasury yields finally seemed to catch up with a previously resilient stock market on Tuesday, leaving the Dow Jones Industrial Average and other major indices for their worst day of 2023 yet.
“Yields are over the curve… This time around, market rates seem to be catching up with Fed funds,” veteran technical analyst Mark Arbeter, president of Arbeter Investments, said in a note. Typically, market interest rates tend to lead the way, he observed.
Since the beginning of the month, traders in fed funds futures have been pricing in a more aggressive Federal Reserve after initially doubting the central bank would meet its forecast for a top fed funds rate above 5%. Some traders are now even pricing in the outside possibility of a peak rate near 6%.
Yield on 2-year Treasury bond TMUBMUSD02Y rose 10.8 basis points to 4.729%, the highest end of a US session since July 24, 2007 9.
“At this point, the bond market has all but abandoned optimistic expectations for limited further rate hikes and a slew of rate cuts in the second half of 2023,” said Daniel Berkowitz, investment director at Prudent Management Associates, in emailed comments .
Meanwhile, the US dollar has also rallied, with the ICE US Dollar Index adding 0.2% to a February rally. Arbeter also noted that breadth indicators, a measure of how many stocks participate in a rally, had previously deteriorated, with some measures reaching oversold levels.
“In the short term, just another perfect run on stock markets,” Arbeter wrote.
Rising yields can negatively impact stocks and increase the cost of borrowing. More importantly, higher Treasury yields mean the present value of future earnings and cash flows are more heavily discounted. That can weigh heavily on tech and other so-called growth stocks, whose valuations are based on earnings far into the future. These stocks took a beating over the past year, but led to a rally in early 2023 and remained resilient until last week, even as yields rallied.
Yields have risen after a string of hotter-than-expected economic data that has raised expectations for Fed rate hikes.
Meanwhile, Tuesday’s weak forecasts from Home Depot Inc. HD and Walmart Inc. WMT also added to weak sentiment in stock markets.
Home Depot fell more than 7%, making it the biggest loser among the components of the Dow Jones Industrial Average
DJIA . The decline came after the home improvement retailer reported a surprise drop in same-store sales in its fiscal fourth quarter, which indicated a surprise decline in profit in fiscal 2023 and earmarked an additional $1 billion to help its employees work better pay.
“While Wall Street is expecting resilient consumers after last week’s solid retail sales, Home Depot and Walmart are much more cautious,” said Jose Torres, senior economist at Interactive Brokers, in a statement.
“This morning’s data is providing rather mixed signals on consumer demand, but during what has traditionally been a weak seasonal trading period, investors are moving towards a glass half full on the back of a year so far that has shown the complete opposite, a glass half full Glase’s perspective,” he wrote.
The Dow fell 697.10 points, or 2.1%, to close at 33,129.59, while the S&P 500 SPX fell 2% to close at 3,997.34, below the mark for the first time since Jan. 20 4,000 points ended. According to FactSet, the year-to-date gain rose to 4.1%, which is less than half the 9% year-to-date gain from its Feb. 2 peak.
The Nasdaq Composite COMP fell 2.5%, trimming its year-to-date gain to 9.8%. The losses caused the Dow to stay slightly negative for the year, down 0.5%. It was the worst day for all three major indices since December 15, according to Dow Jones Market Data.
Arbeter identified a “very interesting cluster” of support just below Tuesday’s low for the S&P 500, with the convergence of a pair of trendlines along with the index’s 50- and 200-day moving averages, all near 3,970 (see chart below ).
“If this zone doesn’t plot the pullback lows, we have more trouble ahead,” he wrote.