What Do Other Markets Indicate for Stocks?

There are, to say the least, some conflicting signals right now for stock traders and investors. The data suggests the Fed will continue to raise rates, but also that the hikes so far haven’t slowed the economy to the point where anyone should be worried. There is obviously cause for concern as higher rates should, in theory, cause some pain, but so far that just hasn’t really been the case.

On top of that, earnings this quarter already look like what we saw three months ago: better than expected results coupled with caution about what to expect in the near future. Nor does consumer behavior shed any light. They have remained resilient but are piling up debt at an alarming rate. In short, everything that an investor would normally rely on for analysis of conditions has two equally valid interpretations, one bullish and one bearish.

To make sense of it, you have to understand the relationships between the various markets and how they are connected.

Working in a dealing room usually involves a great deal of specialization. When I first started in interbank forex, for example, I was on the spot cable desk, meaning that I traded only the British Pound against the Dollar for settlement two days from the trade date. That doesn’t mean, however, that other markets were ignored. In fact, we were far more aware of them than most individual traders who trade in multiple markets typically are. The interconnectedness of markets was impressed on us early and everyone tracked other currency pairs, bond yields, major global stock markets, and commodity prices, even though they weren’t of direct interest from a trading perspective.

Habits formed back then have been very sticky since I left the market. Thus, when I am unsure about direction in the stock market as I am now, I tend to look at other markets for inspiration. So, what are those markets saying?

Even forty years ago, when the U.S. government debt and therefore the Treasury market were much smaller than they are today, the U.S. 10-Year and the ‘long bond,” the 30-Year, were seen as the major drivers of everything. So it makes sense to start there, especially as circumstances have exaggerated the role of yields, particularly in the 10-Year.

The stock market fell for most of 2022 as higher interest rates were factored in but has recovered this year in the hope that the Fed will ease off before any real economic damage is done. That belief is being tested right now, however, as 10-Year yields jumping to well over 4.5% indicate a growing acceptance of the idea of “higher for longer.”

That raises the possibility of an economic environment where, even if a full blown recession is avoided, growth remains anemic for an extended period of time. Obviously, not good for stocks.

As you might expect, with the interest available on U.S. dollar holdings climbing but with inflation not taking too big a bite out of the currency’s intrinsic value, the dollar has gained strength over the last six months or so. DXY, the dollar index, has climbed from around 100 to 107, a big move for that market in a relatively short time. That tells us that even in a “higher for longer” scenario, the big international money that moves the forex market believes that the U.S. economy will be okay, at least relative to the rest of the world.

Then there are commodities, where the state of markets seems to confuse more than clarify. Oil was flying until a couple of weeks ago, but that was more about supply conditions than any belief in economic strength stimulating demand. Then, demand did start to have an influence and crude pulled back to below $85/barrel. It has inevitably bounced again with the situation in the Middle East, but that is once again a supply thing, and the message being sent with regard to global growth remains a bearish one. That is borne out by copper, which has been on a volatile downward trajectory since the end of July, and other commodities that serve as indicators of economic strength and are well off their highs.

Overall, then, there are still mixed messages of sorts when you look at other markets. However, when taken together, they tend to confirm the bearish view rather than the optimistic one so, for now, investors should continue to err on the side of caution.  

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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