Wednesday's Market Minute: We Have a Serious Problem

As rough as the last few weeks have been for stock bulls, it honestly could and probably should be worse. The dollar already broke out, Treasury yields are back at their highs, and bitcoin is diving to year-to-date lows. Yet the S&P 500 is sitting at 3900, a level it first found back in May. Based on recent correlations with all those other assets, you’d think it’d be worse.

But sentiment is some of the bleakest in recent memory. Bulls really believed that the summer rally was the real deal: that a soft patch in the economy and a slight cooling in inflation would be their saving grace. Instead, the screaming bear market rally that saw Apple (AAPL) nearly return to a record is now reversing with remarkable consistency. Frustration is palpable among stock traders because one of their most reliable bullish maxims – that bad economic developments are good for stocks – seems to have finally expired.

Proof is in the yield curve, our best tracking index for the economy. The spread between the 10-year and 3-month rate was steadily trending higher for more than two years until late June. Its summer collapse as the global economic outlook deteriorated aligned perfectly with the rally in stocks. We’ve had some good prints the past few weeks, but the curve remains deeply depressed. But the past three weeks, stocks changed course and are selling off. What changed? Strict wording from Jerome Powell at Jackson Hole that made it clear that weakening conditions wouldn’t cause the Fed to stop fighting inflation.

So if bad data and good data are both bad for stocks, good data is apparently worse, and – generally speaking – economies improve over time, when does this pain trade end? We really have a serious problem when stocks drop regardless of what the economy does. If the only way out is through, it could be one very long haul.

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