Potential Stock Market Stumble: A Closer Look at a Possible Major Pullback

Potential Stock Market Stumble: A Closer Look at a Possible Major Pullback

By William Watts

Treasury yields and oil prices are calling the tune across markets

Stock-market investors enjoyed a smooth ride to a series of record highs for the S&P 500 and Dow Jones Industrial Average in the first quarter. But now, surging Treasury yields and oil prices are calling a different tune.

The Dow DJIA fell more than 500 points shortly after the opening bell Tuesday as equities declined for a second day. The index remained down around 480 points, or 1.2%, in the afternoon, while the S&P 500 SPX was off 0.9%.

A roughly 30% rally off its October low for the S&P 500 leaves stocks seemingly overdue for a pullback, said Sam Stovall, chief investment strategist at CFRA, in a phone interview. The key will be the 10-year Treasury yield, he said.

Indeed, it’s been a sharp and sudden jump in Treasury yields, which move in the opposite direction to bond prices, that’s widely viewed as the trigger for this week’s equity stumble. The yield on the 10-year note BX:TMUBMUSD10Y was up 4.2 basis points near 4.37% Tuesday, after hitting a 2024 high shy of 4.4% earlier in the session.

See: Inflation concerns reverberate for second day, putting a 5% 10-year Treasury yield on the map

Rising yields can be a negative for stocks – in part because they raise borrowing costs for companies, but primarily because they undercut the present value of future profit and cash flow that are the basis for equity valuations.

The speed of the rise can also be important. A rapid move in rates can send ripples across other markets, as it forces investors and traders to liquidate other positions to meet margin calls or rebalance their portfolios.

Meanwhile, a jump in oil prices, in response to rising fears of a broader conflict in the Middle East, is helping to drive up yields and weighing on equities, analysts said.

West Texas Intermediate crude for May delivery (CL.1), the U.S. benchmark, was up 1.4% at $84.89 a barrel Tuesday, after trading above $85 for the first time since October. Iran has vowed to retaliate for an Israeli strike in Syria that killed a top Iranian general on Monday.

Rising crude prices and the jump in Treasurys set up an echo of the market dynamic that sent stocks sliding back in October, said Jose Torres, senior economist at Interactive Brokers, in a Tuesday note. Rising oil underscores concerns about a sticky inflation picture, which could endanger expectations that the Federal Reserve will deliver three quarter-point rate cuts in 2024.

“While the central bank seems comfortable with inflation 50% to 75% above [its 2%] target for the time being, sharp increases in commodity prices are unacceptable for the general trend of price pressures, as they’ll eventually start to prop up costs for both services and goods,” Torres wrote. “Investors are taking advantage of these headwinds to book profits in risk assets and shift to safer havens.”

Will the selloffs in Treasurys and stocks continue? No one has a working crystal ball, and recent stock-market dips have quickly been met by buyers. A Feb. 13 downdraft sparked by hotter-than-expected January inflation data saw the Dow drop nearly 760 points at its low, before the blue-chip index and the S&P 500 both ended the day down 1.4%. Major indexes soon returned to record highs.

A busy week of economic data and remarks by Federal Reserve officials are expected to be key market drivers in the week ahead, with the March jobs report due on Friday.

The stumble to begin April “reminded investors that if yields break out, it will become a headwind on the broader market,” said Tom Essaye, founder of Sevens Report Research, in a note. “The net impact was to increase the importance of this week’s economic data, specifically Wednesday’s ISM Services PMI and Friday’s jobs report. If both are ‘hot,’ risingyields will pressure stocks.”

-William Watts

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04-02-24 1420ET

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