Good news is bad news again


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Strong economic data has investors racing…the relationship between the 10-year Treasury yield and the S&P…what will boost your portfolio in 2023…the latest economic data

We are back to “bad news is good news” and vice versa.

Wall Street hates headlines about a resilient economy and a strong workforce, and applauds anything that hints at weakness.

To unpack this and get an idea of ​​what this means for your wallet, let’s check with our technical experts John Jagerson and Wade Hansen from Strategic Trader.

They begin their final analysis by directing readers to what they believe will be the fate of the S&P in 2023…

The 10-year Treasury yield.

For new Digest readers, the 10-year Treasury yield is one of the most important influences on the value of your stock portfolio.

This for two main reasons:

First, as this yield climbs, 10-year Treasury bonds become a much more attractive investment alternative to stocks for many conversational investors.

For example, last October, the 10-year Treasury paid investors a return of 4.2%. And if held to maturity, this investment presented no risk of loss of principal (unless the US government imploded).

Compare that to an investment in the S&P with its meager 1.74% dividend yield as I write, not to mention the risk of big capital losses as the bear market continues.

Second, the higher the 10-year Treasury yield, the higher the “risk-free” rate that Wall Street uses in its valuation models when trying to put a fair value on stock prices. In general, the higher this risk-free rate, the lower the expected stock price.

To illustrate the relationship between the 10-year Treasury yield (TNX) and the S&P, let’s look at John and Wade:

… We have seen a direct inverse correlation between the value of the TNX and the value of the S&P 500 (SPX) over the past seven months. When the TNX forms lower highs, the SPX forms higher lows.

This relationship seems to continue until 2023.

You can see this inverse relationship in the graph below. The 10-year Treasury yield is in black, the S&P is in green.

Source: StockCharts.com

Back to John and Wade:

Here’s how the relationship has gone since October…

1. Mid-October
– TNX jumped to a high of 4.3% for the first time since the 2008 financial crisis
– The SPX fell to a low of 3,500

2. Early November
– The TNX set a lower high at 4.2%
– The SPX set a higher low at 3,700

3. Now (early January)
– TNX reached resistance at 3.9% and fell back to 3.7%
– The SPX has found support at 3,800 and is climbing back above 3,854.90

So where will the 10-year yield – and by extension, the S&P – go from here?

John and Wade think it comes down to Wall Street’s expectations for Fed policy here in 2023.

If Wall Street starts pricing in more interest rate hikes this year, we’ll likely see 10-year rates rise, which will weigh on the S&P.

But if Wall Street thinks fewer interest rate hikes are ahead, the 10-year yield will fall, paving the way for a rally in the S&P.

This points us to the logical follow-up question: what will impact Wall Street’s expectations for the direction of the 10-year yield?

Back to John and Wade:

Economic announcements.

If Wall Street sees signs of the U.S. economy contracting, it will expect fewer rate hikes from the Fed, as signs of economic contraction indicate that rate hikes already made are having their intended effect. .

If Wall Street sees signs that the U.S. economy is expanding (or at least not contracting), it will expect further rate hikes from the Fed, as signs of economic expansion indicate that the rate hikes already implemented are not having the desired effect.

And that brings us back to the point where “bad news is good news” and vice versa.

Encouraging data on the economy is now bad news for equities, as it means the Fed will remain aggressive with rate hikes – impacting the 10-year Treasury yield and, therefore, the value of your shares.

We saw this dynamic play out yesterday with the surprisingly strong ADP jobs report

Let’s go to CNBC for what happened:

The labor market ended 2022 on a high note, with companies adding far more positions than expected in December, payroll processing company ADP reported Thursday.

Private payrolls rose 235,000 for the month, well ahead of the Dow Jones estimate of 153,000 and the 127,000 originally reported for November.

True to form, the S&P tumbled yesterday, falling 1.2% as investors feared strong jobs numbers would push the Fed to keep raising interest rates.

In their Strategic trader Wednesday update, John and Wade pointed to two other recent reports that offer conflicting clues about economic health:

So far this week, we’re getting mixed messages.

The ISM Manufacturing PMI (Purchasing Managers’ Index) number came in at 48.4, which was a positive sign for the SPX.

(Note: The PMI is a diffusion index. Any number > 50 indicates economic expansion, and any number
However, JOLTS job openings came in at 10.46 million instead of the expected 10.04 million. It was a negative sign for the SPX.

Seeing higher-than-expected job vacancies indicates a tight labor market, which means wages (and therefore inflation) should continue to come under upward price pressure.

John and Wade also pointed to the minutes from the Fed’s December meeting, which we commented on in yesterday’s Digest.

In short, the commentary was hawkish, revealing that members seem reluctant to ease monetary policy anytime soon.

This morning, we received three economic data

We learned the latest numbers on the evolution of non-farm payrolls, the average hourly wage and the ISM Service PMI.

Nonfarm payrolls came in hotter than expected, climbing 223,000 from expectations of just 200,000. Not good news.

But on the average hourly wage front, the data was encouraging. Here is CNBC:

Wage growth has been below expectations, indicating that inflationary pressures may be easing.

Average hourly earnings rose 0.3% for the month and 4.6% from a year ago. The respective estimates were for growth of 0.4% and 5%.

This is good news, as the Fed has been very nervous about wage increases.

Finally, the ISM Service PMI posted a contraction for the first time in more than two and a half years thanks to weaker demand. The report also showed that prices paid by businesses have slowed significantly, another piece of data suggesting that inflation is slowing.

This PMI report isn’t great news for the economy, but it does mean it’s great news for Wall Street which wants to see weakness.

And in fact, as I write Friday morning, all three major indexes are up more than 1%. Wall Street seems to applaud the “slowing economy/cooling inflation” aspect of these reports.

Here are John and Wade’s results to get us out today:

If the labor market continues to strengthen, this could dampen any upward movement in the SPX.

But if we see some easing, it could pave the way for equities to rise.

Have a good evening,

Jeff Remsburg

The post Good News is Bad News Again appeared first on InvestorPlace.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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