Market decline

Rates, Fed and market decline: the stock market collapses

September was a month of decline for the stock market, and market risk became significantly higher. For a number of months, we watched the grind pick up speed as the shrinking market scope continued to warn of a weakness in the domestic market.

Over the past month, the market finally collapsed. Below is a chart of the S&P 500, which has trended higher using its 50-day moving average as support for any minor pullbacks. That momentum collapsed last month when the index fell significantly below that moving average. Now the average acts as a resistance.

The levels that I will be watching as possible support areas are around 4260 (indicated by the blue horizontal line) and the 200 day moving average. If the index falls below its 200-day moving average (about 5% below Friday’s close), it would be extremely bearish for the market.

Market scope continues to deteriorate

The scope of the market continues to deteriorate. The major stock indexes (weighted by capitalization) continue to climb, however, the number of stocks participating in this advance has been declining for months.

Below is a chart of the S&P 500 Summation Index (an indicator of the breadth of the market) in the top panel. Notice how, over the past five months, the S&P 500 Index has risen while the Summation Index has fallen.

Recent market weakness has pushed the sum into negative territory. I consider the stock market risk to be very high whenever the index drops below zero.

S&P 500 Summation Index.

Bond yields burst

Historically, the rise in bond yields has been bullish for stocks in that it is a sign of economic growth that offers a strong tailwind for the stock market. On the other hand, falling yields can be a sign of weakness and decline for stocks.

Note in the chart below how yields peaked in May, which seems to coincide with the fall in the Summation Index as well as other width indicators.

So why is the stock market crashing as rates rise? Shouldn’t rising yields be a welcome sign for stock market investors?

If the rate hike was driven by economic strength, I would expect transportation stocks (both of which are economically sensitive) to advance. Notice in the table below how they have been going down for months. The recent rate hike has not been matched by corresponding strength in areas that generally benefit from economic strength.

I think investors see the rise in rates as primarily due to inflation, not economic strength. This, combined with a Fed that has become hawkish, worries the market.

If that momentum doesn’t change soon, it could create more downside for stocks.