Stocks drop as yeilds rise

Finally, it crossed the line. For the first time since January 2014, the US 10-year Treasury yield briefly rose above the key 3% level before dipping lower again. Yields in Europe also rose, which kept the EUR/USD supported after its recent sharp declines. But the stock market reacted negatively to the rising yields. Market participants are once again showing signs of concern about the prospects of higher interest rates weighing on economic growth. This is despite the release of mostly positive company earnings results from the US.

With stock indices still at lofty levels, and with yields rising, things could turn ugly quick. But should investors really worry about higher yields? Well, in normal circumstance probably not. But given that it was the low and falling yields that supported the stock markets in the first place, overvalued equities should come under pressure should yields remain high. So far, the 3% yield on the 10-year debt has acted as a bit of resistance. But if we close above it today or in the coming days then that should encourage further selling in the bond markets in the days to come. And if bonds fall further then so too should equities, one would think, especially since stocks are still overvalued.

Form a technical perspective, the S&P 500 future (ES) looks quite bearish. It has potentially created another lower high last week around the technically-important 61.8% Fibonacci level (point C on the chart). Today’s failed attempt to hold above Monday’s high suggests the breakout bullish traders are again trapped – perhaps somewhat similar to the previous occasion on 12-13 March when the index tried to break above the previous high (point A) and there was no follow-through.

Going forward, one needs to watch support at 2660 closely now. If this level were to break down decisively then there is not much in the way of support until the 200-day average at 2607. Below this moving average we have pools of liquidity i.e. cluster of sell stop orders beneath the previous two lows at 2552 and 2529, respectively. These orders may attract the market towards it in the coming days and weeks, which could eventually see the index drop to the AB=CD target of around 2465/7, which is also where the long-term 38.2% Fibonacci level converges.

At this stage, only a break back above the most recent high at 2718 (i.e. point C) would invalidate the short-term bearish outlook. Even then, the longer term outlook would remain murky for as long as the index remains below the previous high at 2807 (i.e. point A). In other words, until it creates a clear higher high.