Rising Yields And Higher Neutral Rate May Spoil The Party, Biggest Stock Moves In Years Ahead

To gain an edge, this is what you need to know today.

Biggest Stock Moves Ahead

Please click here for an enlarged chart of iShares 20+ Year Treasury Bond ETF TLT.

Note the following:

• TLT moves inverse to the yield. The higher the yield goes, the lower TLT falls.
• The chart shows the move up in TLT in anticipation of Fed rate cuts.
• The chart shows a breakout above the resistance zone.
• The chart shows when the Fed cut rates.
• The chart shows that the spot on Arora call was made on the same day that the Fed cut interest rates. The Arora call was made in advance of the Fed announcement, giving investors more time to act. The Arora call was that yields were likely to rise on long bonds, sending TLT lower. The Arora call was a contrary call squarely going against the prevailing wisdom at that time. At that time, the following described the landscape.
  • Technically oriented investors were buying TLT because of the technical breakout.
  • Macro investors were buying TLT because of the rate cut. Going into the Fed meeting the consensus was still a 25 bps cut, even though the idea of a 50 basis point rate cut was gaining steam.
  • The prevailing wisdom in the market was that TLT would go up.
• The chart shows that the breakout failed, and TLT has experienced a significant drop since the Arora call.
• The chart shows that TLT is now getting closer to the top support zone.
• The down move in TLT is remarkable because during this time, the money has been flowing into the safety of long Treasury bonds due to escalating conflict in the Middle East. In The Arora Report analysis, if it was not for the Middle East conflict escalation, TLT would have already fallen into the top support zone.
• RSI on the chart shows that TLT is oversold. An oversold ETF often bounces.
• In The Arora Report analysis, unless the economic data changes or a war breaks out, or the Fed changes its course, any rally in TLT has a 70% probability of failing. The reason behind this prediction is that irrespective of who is elected, Trump or Harris, the government's borrowing and spending is going to go up. Higher borrowing means a larger supply of Treasuries.  A larger supply of Treasuries indicates a higher yield on long bonds. If the U.S. has a divided government after the election, the borrowing will be less than it will be if either party sweeps. In the event of a one party sweep, TLT can potentially fall to the bottom support zone.
• Investors should also pay attention to the10 year Treasury yield.  The 10 year Treasury yield is important because it is the reference rate for computing appropriate PE ratios in most models. In general, the rule is higher interest rates mean lower PE ratios. There are two reasons for this:
  • When interest rates are higher, the value of future earnings discounted to present is lower.
  • When bonds start paying higher interest rates, they offer more competition to stocks.
• The yield on 10 year Treasuries has risen from 3.68% on the day the Fed cut the interest rate to 4.031% as of this writing.
• Contrary to expectations in the market, mortgage rates have also risen since the Fed rate cut.
• Investors should also pay close attention to the neutral rate. The neutral rate is the Fed funds rate that is neither restrictive or expansionary.
  • In addition to the neutral rate, investors should also pay attention to the pace at which interest rates come down to the neutral rate.
  • The Fed is indicating that the neutral rate might be around 3.4% in 2025. Previously, the Fed was pointing to a long run neutral rate of 2.5%.
  • The prevailing wisdom in the market is that the neutral rate is in the range of 2.5% – 3.5%.
• Regarding the neutral rate, The Arora Report has another contrary call. Unless economic data substantially changes or geopolitical conditions substantially change, the likely neutral rate is higher than the market consensus. In The Arora Report analysis, the likely neutral rate is 3.25 – 4.25%. 
• The foregoing discussion on the long bond rate, 10 year rate, and neutral rate is very important because in view of The Arora Report analysis and contrary calls, earnings will have to be very robust for the stock market to advance from here and sustain at a higher level.
• In The Arora Report analysis, implied volatility of options on popular individual stocks around earnings indicates that the biggest moves after earnings in recent years in individual stocks are ahead. This has two practical implications for investors:
  • This will provide more opportunities for prudent investors who are set up to systematically take advantage of volatility in a proven way instead of being afraid of volatility.
  • Some of the existing positions in portfolios may be hit hard. To balance it with stocks that move up significantly, it is important to make sure the portfolio is properly diversified.
• In The Arora Report analysis, prior to the jobs report, the probability of a 50 bps cut after the next Fed meeting was about 30%. Now, the probability has dropped to 5%.
• Based on The Arora Report proprietary sentiment indicator, sentiment in the stock market is very positive.  S&P 500 at 6000 is the magnet for traders.  
• Based on The Arora Report's proprietary methodology, numerous short squeezes are taking place, adding to the upside moves in individual stocks.
• There is renewed excitement in AI stocks. The main reason is that NVIDIA Corp NVDA AI Summit is taking place.
• There is also buying ahead of Advanced Micro Devices, Inc. AMD analyst meeting about AI on October 10.  Hewlett Packard Enterprise Co HPE will also highlight its progress on AI during its analyst day on October 10.
• Adding to excitement in the stock market is the upcoming Tesla Inc TSLA robotaxi event on October 10.
• Consumer Price Index (CPI) will be released on October 10. Headline CPI consensus is 0.1%.  Core CPI consensus is 0.2%.
• Hurricane Milton is barreling towards Florida.  Insurance stocks such as Universal Insurance Holdings, Inc. UVE, Heritage Insurance Holdings Inc HRTG, and HCI Group Inc HCI are seeing selling pressure.  Generator manufacturer Generac Holdings Inc GNRC is seeing buying pressure, so are roofing stocks such as Beacon Roofing Supply Inc BECN and Owens Corning OC.
• Volatility index (VIX) continues to stay high on anxiety about the Middle East. VIX is elevated at 22 as of this writing.
• As an actionable item, the sum total of the foregoing is in the protection band, which strikes the optimum balance between various crosscurrents.   Please scroll down to see the protection band. The protection band is one of the large number of unique edges that are available to members of The Arora Report.

China Disappoints

We have been sharing with you day by day the epic rally in Chinese stocks and the reasons behind it. Today, at the beginning, hopes were high as Mainland China investors returned after a one week holiday.  Mainland benchmark stock index CSI 300 jumped 11% at the open but subsequently lost some of the gains, finishing up 5.9%.  In spite of the pullback, CSI 300 is up about 30% over the last month.

In Hong Kong, Hang Seng lost 9.41%. This is the biggest drop since the 2008 financial crisis. Stocks in Hong Kong were trading during the mainland holiday. The reason for the disappointment is that investors were counting on the National Development and Reform Commission (NDRC) to offer concrete stimulus measures at a briefing. However, the chair of NDRC Zheng Shanjie did not offer new concrete stimulus steps. This disappointed traders.

As full disclosure, for those who understand the China risk, The Arora Report’s plan continues to be to buy Mainland China ETF Xtrackers Hvst CSI 300 China A Shs ETF Class A ASHR and Hong Kong ETF iShares China Large-Cap ETF FXI when they fall in the recently updated buy zones in The Arora Report’s ZYX Emerging.

Magnificent Seven Money Flows

In the early trade, money flows are positive in Apple Inc AAPL, Amazon.com, Inc. AMZN, Alphabet Inc Class C GOOG, Meta Platforms Inc META, Microsoft Corp MSFT, NVDA, and TSLA.

In the early trade, money flows are neutral in Microsoft Corp MSFT.

In the early trade, money flows are positive in SPDR S&P 500 ETF Trust SPY and Invesco QQQ Trust Series 1 QQQ.

Momo Crowd And Smart Money In Stocks

Investors can gain an edge by knowing money flows in SPY and QQQ.  Investors can get a bigger edge by knowing when smart money is buying stocks, gold, and oil.  The most popular ETF for gold is SPDR Gold Trust GLD.  The most popular ETF for silver is iShares Silver Trust SLV.  The most popular ETF for oil is United States Oil ETF USO.

Bitcoin

Bitcoin BTC/USD is range bound.

Protection Band And What To Do Now

It is important for investors to look ahead and not in the rearview mirror.

Consider continuing to hold good, very long term, existing positions. Based on individual risk preference, consider a protection band consisting of cash or Treasury bills or short-term tactical trades as well as short to medium term hedges and short term hedges. This is a good way to protect yourself and participate in the upside at the same time.

You can determine your protection bands by adding cash to hedges. The high band of the protection is appropriate for those who are older or conservative. The low band of the protection is appropriate for those who are younger or aggressive.  If you do not hedge, the total cash level should be more than stated above but significantly less than cash plus hedges.

A protection band of 0% would be very bullish and would indicate full investment with 0% in cash. A protection band of 100% would be very bearish and would indicate a need for aggressive protection with cash and hedges or aggressive short selling.

It is worth reminding that you cannot take advantage of new upcoming opportunities if you are not holding enough cash.  When adjusting hedge levels, consider adjusting partial stop quantities for stock positions (non ETF); consider using wider stops on remaining quantities and also allowing more room for high beta stocks.  High beta stocks are the ones that move more than the market.

Traditional 60/40 Portfolio

Probability based risk reward adjusted for inflation does not favor long duration strategic bond allocation at this time.

Those who want to stick to traditional 60% allocation to stocks and 40% to bonds may consider focusing on only high quality bonds and bonds of five year duration or less.  Those willing to bring sophistication to their investing may consider using bond ETFs as tactical positions and not strategic positions at this time.

The Arora Report is known for its accurate calls. The Arora Report correctly called the big artificial intelligence rally before anyone else, the new bull market of 2023, the bear market of 2022, new stock market highs right after the virus low in 2020, the virus drop in 2020, the DJIA rally to 30,000 when it was trading at 16,000, the start of a mega bull market in 2009, and the financial crash of 2008. Please click here to sign up for a free forever Generate Wealth Newsletter.