The S&P 500 and Nasdaq 100 equity indices are on track to post their third consecutive red candlestick on the weekly chart for the first time since February 2023 and December 2022, respectively. After a relentless year-to-date rally, fund managers seem to be starting to lock some profits or rebalance their portfolios amid the ongoing risk of overtightening as the US economy continues to exhibit remarkable resilience. However, there is a plethora of additional risks that investors should have in mind.
Rising yields bite stocks
In 2023, major US indices have experienced significant gains despite the deteriorating macroeconomic backdrop and the aggressive interest rate hikes by most central banks around the globe. The excess liquidity in the system has been the main driver behind this rally, with stocks defying rising Treasury yields for the biggest part of the year.
However, this phenomenon seems to be fading as the latest pullback in the equity space coincides with a significant spike in the 10-year Treasury yield. This advance comes on the back of a series of upbeat US data, which increased the prospect for an additional 25 basis points rate hike despite the latest FOMC minutes pointing to split views on the inflation outlook.
Besides that, there is heavy supply of US Treasuries on the horizon as the budget deficit has exploded, while diminishing demand from China and the recent ratings downgrades are applying more upside pressure on yields. Right now, the base case scenario for the US economy consists of a soft landing, but the risk of overtightening due to interest rates’ lagging impact on the economy could easily turn things around.
Earnings take the backseat
As we are approaching the end of the Q2 earnings season, it is safe to say that once more most US companies managed to clear the low bar set by analysts albeit earnings keep contracting on an annual basis. According to FactSet, earnings for the S&P 500 are on track to decline 5% year-on-year against expectations of a 7% drop heading into the earnings season.
Surprisingly, this relative outperformance has failed to lift stocks higher as investors appear to be focusing more on what has been happening in the bond market.
China woes undermine risk sentiment
Last but not least, risky assets have been under pressure from rising concerns over China’s economic recovery. A raft of economic releases came out on the bearish side, while a liquidity crisis in one of the biggest domestic property developers has triggered contagion fears, bringing back memories of Evergrande’s default. Even though these risks are not directly linked to US stocks, they have been responsible for the broader risk-off mood we have been seeing in global markets lately.
Temporary pullback or evolving downtrend?
From a technical perspective, the Nasdaq 100 has been experiencing a moderate pullback from its 2023 highs, falling below the 50-day simple moving average (SMA) for the first time since March. Will this be a temporary correction or the first leg of a sustained downtrend?
If the price extends its retreat, the June support of $14,687 could act as the first line of defence ahead of the $13,720 hurdle.
On the flipside, should the price storm back higher, the bulls are likely to encounter resistance at the June high of $15,284 before the 2023 peak of $15,932 gets tested.
