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Rates Stumble As SPX Readies To Test Highs - Morning Market Squeeze

Correlations are forever changing, and as we show on page 7 the cycle has been growing increasingly closer to 1.0 between stocks and bond yields. With CPI coming in on the cool side yesterday, this correlated dance of higher highs suffered a setback that, as of now, has been more damaging to longer-dated rates than to the S&P 500. Key Tactical Takeaways:


> We still want to be buyers of any pullback to the 346 area in SPY, as we think the S&P 500 is setting up for another thrust higher to mark the end of the most aggressive pace of gains. Therefore, we're tightening stops on profitable longs.


> After failing to maintain its tactical late-September breakout earlier this month, there's nothing to suggest that the dollar has what it takes to continue rallying hard after Tuesday's strong bounce. 


> While technology has recovered relative to utilities in recent days, this improvement has yet to fix the longer-term trend damage done to the risk vs. risk aversion picture over the near-term.


> Even though XLF dropped in the wake of better than expected Citi/JPM earnings and a sharp drop in Treasury yields on Tuesday, the short-term bull stop at 24.98 held, keeping the focus leaning to the 25.90 area.


Some Quick Thoughts:


Last week, the growing correlation between the S&P 500 and inflation expectations began to make its way back onto our radar. Correlations are forever changing, and as we show on page 7 the cycle has been growing increasingly closer to 1.0 between stocks and bond yields. With CPI coming in on the cool side yesterday, this correlated dance of higher highs suffered a setback that, as of now, has been more damaging to longer-dated rates than to the S&P 500. 


As one would expect, Tuesday's sharp drop in rates caused tumult in the financials sector, with XLF sustaining the largest sector decline (-1.9%), even as both Citi and J.P. Morgan reported earnings that beat analyst expectations. While the XLF's reversal to a 3-day low did leave a rather indelible mark on the daily chart, this key sector did manage to close above its bullish trailing stop at 24.98. For the 10-Yr yield, however, the drop below the 0.74% ST Noise Buffer was more damaging, as it turned the benchmark yield's short-term trend from up to sideways/neutral.


Bottom Line: When correlated market trends are in the process of developing, there's always going to be differing degrees of countertrend setbacks amongst the various asset classes.  While the 10-Yr yield suffered meaningful short-term damage on Tuesday, the case for ongoing rotation to higher rates over the near-term is still very much intact against 0.71%. For the S&P 500, yesterday's drop is just a pause within what the pattern suggests is the most aggressive part of any rally (3rd wave). If correct, however, this aggressive rally phase is nearing its end, and we need to start preparing for a more volatile period, though still with a higher bias, the closer things get to the election.   

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