What Will Higher Rates Mean?

Even though the second quarter GDP on Thursday was revised to a 31.7% decline, it did not stop the stock market from moving even higher, as once again the large tech stocks led the way.

As we end August, which is normally not a great month for stocks, seven of the thirty Dow Jones Industrials stocks are showing double-digit gains for the month. However, it should also be noted that fourteen Dow stocks are still negative for the year.

The gains for the week were solid, as both the Nasdaq 100 NDAQ , Dow Jones Transportation Average, and S&P 500 were up over 3%. The small-cap iShares Russell 2000 was only up 1.6%, just ahead of SPDR Gold Shares, up 1.3%. The Dow Jones Utilities Average was down for the week.

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Both the S&P 500 and DJIA look ready to have their best August performance since 1984. Even though the S&P 500 earnings were down 31.8% for the quarter, 84% of S&P 500 stocks reported higher earnings than analysts had estimated, as expectations were low. It may be more difficult for these companies to beat estimates next quarter.

Many investors are aware that the stock market does not generally perform well in September and October. The seasonal analysis in the chart is based on the data going back to 1928, which reveals that the market historically peaks out at the end of August or early September. The market then typically bottoms in late October and November before it turns higher. Including 1929 and 1987, there have been a number of other years that have contributed to investors’ low expectations in the fall.

Over the past ten years, the worst September was in 2011, when the S&P 500 declined by 7.2%. That year the market turned lower in July, when the US debt was downgraded. By September 2011, many were convinced that the US had started a new recession, but instead the market bottomed in October, and bull market resumed.

As I always point out when discussing seasonal analysis, the technical studies need to agree with the seasonal trend before you take action. Last week, the NYSE Advance/Decline numbers were positive, with 2111 issues advancing and just 983 declining. The ratio was almost 2-1 negative for the week ending August 21. A second week of negative A/D numbers would have allowed for a deeper correction, but this did not happen.

The monthly chart of the Invesco QQQ Trust (QQQ) QQQ with one trading day left in August shows that it is well above the monthly starc+ band. The QQQ was also above this band in July, which this is a sign that it is in a high-risk buy area. That does not mean that it cannot still go higher, but the probabilities of higher prices have decreased.

In early 2018, the monthly starc+ bands were also exceeded (point 2) before the market’s sharp correction. The declines below the monthly starc- bands in late 2018 and in March of this year (points 3) were indications that the stock market was stretched on the downside.

The monthly Nasdaq 100 Advance/Decline line made a new high in March of 2016 (point 1) which was a sign that the correction of 2015 and early 2016 was over. It will make a significant new high in August, but appears extended, having moved much further above its weighted moving average (WMA), which is rising.

There are other signs that the stock market is losing strength. The percentage of S&P 500 stocks above their 20-day exponential moving average (EMA) has formed lower highs since it peaked in June (line e). This is also true of the percentage of stocks above the 50-day EMA, (line f). Both readings have diverged from prices which have made higher highs (line d).

This is similar to what happened in early 2020, as the S&P 500 was moving higher (line a). The percentage of S&P 500 stocks above their 20-day EMA formed a series of lower highs (line b) in January and February before the market collapsed. The percentage of stocks above their 50 day EMAs also formed a series of lower highs (line c).

The economic data last week was mixed, as Tuesday’s Consumer Confidence came in at 84.8, well below the expected reading of 93. In contrast, the Consumer Sentiment on Friday was stronger than expected at 74.1, which was up from the mid-month reading of 72.8.

Also on Friday, the Chicago PMI at 51.2 was a bit lower than last month, while Consumer Spending rose 1.9%. That was a bit better than expected by economists, but without further stimulus action by Congress, next month’s report may not be as strong. Thursday’s new policy framework from the FOMC now allows inflation to run over 2%.

Interest rates increased last week, as the yield on the 10-Year T-Note Yield closed at 0.729%, breaking the daily downtrend (line b). The early June high at 0.957% is the next resistance level to watch with the longer-term downtrend (line a) at 1.179%. If this trend of higher rates continues, it will have important implications for sector performance.

The increase in yields helped the financial stocks, with the Financial Sector Fund (XLF) XLF up 4.54% for the week. After a rough summer for the Financial Sector, it was up almost as much as the Communication Services (XLC) XLC and Technology Services (XLK) XLK , which were up 4.6% and 4.4% respectively.

In September of 2016, rates also rose ahead of the election and moved higher for the rest of the year. Yields peaked in March of 2017. Given seasonal tendencies and divergences between price and some of the indicators, investors and traders should focus on the risk rather than the reward going into September.

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