A dead cat bounce on stocks
Hey there,
What happens when you throw a dead cat out the window?
It hits the ground, bounces, then falls again.
After December's violent 5% market decline and the following rebound, many are asking if we're witnessing a similar phenomenon in stocks.
The Bond Market Connection
To understand today's market dynamics, we need to look at what's happening in bonds.
The relationship between stocks and bonds runs deep - they traditionally comprise the largest portions of investor portfolios, with managers constantly adjusting positions based on relative attractiveness.
Recently, the 10-year Treasury yield surged from 3.6% in September to 4.6% - a 25% jump in just 100 trading sessions.
Moves like this are rare and have massive implications for the stock market.
When wealth managers see their portfolios potentially overexposed to stocks while bond yields become increasingly attractive, they often rebalance.
This shift from stocks to bonds for steady returns explains why spiking interest rates, like today, create market risks.
The last 4 similar rate spikes occurred in March 2022, September 2022, August 2023, and April 2024.
Each preceded market drawdowns ranging from 5% to 10%.
But it’s important to remember that past performance doesn't guarantee future results - each market moment is unique.
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Today's Unique Situation
Unlike 2022's rate spikes, driven by aggressive Fed tightening, today's surge comes during a period of rate cuts.
So, what’s changed?
The key shift lies in the Fed's future projections.
Just 3 months ago, the Fed expected 6 rate cuts in 2025. Now they project just 1.
This shift in expectations has driven the 10-year yield higher.
The current environment closely resembles the late 1990s, when stable Fed rates coincided with one of history's most incredible bull markets.
This parallel also supports our generally optimistic market outlook.
But risks of a short-term correction cannot be completely ruled out.
Warning Sign - Homebuilders
Homebuilder stocks, which are traditionally leading market indicators, still remain depressed during this ongoing market bounce.
This suggests the S&P 500 could face short-term pressure again.
We saw a similar behavior in March 2022, before a significant market decline.
Back then, the broad market bounced while homebuilders stayed weak, eventually leading to a broader market reversal.
But, today's technical picture differs from 2022.
Back then, moving averages were curling downward, showing bearish momentum.
Currently, key moving averages point upward with the S&P 500 above them - a significantly more constructive technical setup.
Our Current Strategy
While maintaining overall market optimism, we acknowledge short-term risks.
A correction to 5,600 points appears possible, leading us to adjust positions accordingly.
We've taken profits on several successful trades and implemented hedges using a 3x leveraged short ETF on the S&P 500 for protection.
Despite these defensive moves, we maintain net long exposure.
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