“Doom Loops” Might Be Signaling a Market Bottom
A good friend and colleague, who has done well as an investor, recently asked me (I’m not making this up, we were standing at the water cooler) what I thought about the “doom loop” in the markets. It seems he had just read an article penned by one of Wall Street’s popular so called Prophets of Doom and he was deeply concerned about the future and the fate of his portfolio.
Perplexed, I asked him, “which doom loop” he was referring to. There are so many existing, developing, and potential catastrophes currently unfolding, each with plausible negative effects on investments and life in general.
My friend was puzzled by my genuine query, confirming my observations about the quiet panic that recent events had led to in the investment public, which I’ve been chronicling here. I then proceeded to note several potential “doom loops” that I saw and he nodded in understanding as he was able to see that the article he had read, although plausible and well-reasoned, depicted just one of many potential dark scenarios facing humanity.
I then suggested that rather than being constantly worried, maybe it’s best to just accept that someday things will go wrong, as they eventually do in all economic and political cycles. I also noted that from a stock investing standpoint, it’s always best to focus on the present while being prepared for that day in which things will change.
Then I discussed some of the points which I will highlight in this article with him and he seemed to feel better. I’m hoping that if you’re a worried investor, you too may glean some calm and perhaps gain some perspective from this article.
Just to be clear. I take the unfolding events in the world seriously and fervently hope that things will work out in a peaceful manner. It’s also fair to ask if what’s happening today is any different than what history shows can happen during any era.
Uncertainty is part of reality. And as investors, it pays to acknowledge its daily presence and to consider its potential effects on our portfolios. It’s equally prudent to prepare, as best as possible, for any and all circumstances, every single day.
Recent History and Contrarian Thought
The last 12 months have been a perfect example of how uncertainty has provided profitable opportunities to investors. Almost a year ago, in October 2022, I suggested that a market bottom was forming as investor sentiment was reaching climactic levels of negativity. By January, the market had bottomed and by March, the artificial intelligence-fueled rally, which lasted into July 2023, delivering huge profits had blossomed.
Investors who were still focusing on the worry list from the fall of 2022 missed the rally. Contrarians who focused on the markets, instead of the lingering fear, likely made money.
Flashing forward to the last two months, we’ve seen a rebuilding of the wall of worry, with equally bullish potential. This time the pessimism was fueled by rising bond yields combined with the Federal Reserve’s talk of keeping rates “higher for longer.”
What Really Happened in the Bond Market
Interestingly, the Fed is starting to soften its tone as they realize that the recent rise in bond yields may have finished the job for them. Moreover, the dramatic rise in yields, as The Daily HODL recently reported, had less to do with inflationary fears amongst investors, as was widely reported by media sources, than reported. That’s because the bond market rout was at least partially attributable to the combined selling of $17.4 billion in U.S. Treasuries by China, Brazil, and Saudi Arabia in the month of September alone.
Why they sold is well above my pay grade and the scope of this column. But anyone who knows markets would have noted this was not the type of signature selling from big trading houses and hedge funds.
Here’s what I mean. Fidelity, Vanguard, Pimco, T. Rowe Price, or any major bond investor would never sell bonds in that rapid fire non-stop manner, as the portfolio losses created by that type of selling would hit their earnings and perhaps the ability to operate the company. Only a financially insensitive group, such as the three governments reportedly involved would conduct such a campaign.
That’s because governments are often fiscally irresponsible and don’t have to answer to investors. Moreover, once normal market forces eventually take over, as they seem to be doing presently, the ensuing short covering rally would add to the losses.
It Pays to Step Back and Analyze Market Relationships
The relationship between interest rates and stock prices is about as sure a thing as there is. It’s as simple as higher interest rates are bad for stocks and lower interest rates are good for stocks. It’s equally important to appreciate when that relationship is nearing a point of potential reversal.
Last week, in this space, I suggested contrarians should prepare for a stock market rebound, as bond yields were reaching a point of absurdity and the Fed’s trash talking about keeping rates was rising to a fever pitch, yet stocks were showing signs of forming a potential bottom.
A week later, my contrarian thesis is being bolstered by an increase in money flows into stocks as bond yields return to more realistic action. The price charts of the U.S. Ten Year Note yield (TNX) and the Invesco QQQ Trust (QQQ) illustrate the point quite clearly.
The price chart for TNX shows the reversal to the means I’ve been expecting is developing. Note that TNX traded as high as 4.9% recently while simultaneously moving outside the upper volatility band (aka Bollinger Band – blue line above yields). That’s a sign that the trend was overheating and that a reversal was likely. You can see a similar pattern way back in October 2022 before a sharp downside reversal which spawned a months long rally in stocks.
The rolling over in TNX is again spurring a reversal in stocks, as is evident in the price chart for QQQ. As I noted last week, this ETF is a great trading vehicle for capturing the market’s general trend. Recently, QQQ found support at the $350 price point; preceded by these important technical signs:
- Accumulation/Distribution (ADI) bottomed out in mid-September as short sellers covered; and
- On Balance Volume (OBV) bottomed in August, turning up in early September as buyers moved back in;
Meanwhile, the New York Stock Exchange Advance Decline line (NYAD) just crossed above its 200-day moving average, a bullish turn. Unless this reverses the odds of the rally in stocks picking up steam will continue to rise.
Putting it All Together
The odds of a sustainable stock market bottom and ensuing rally are rising. This bottom emerged as the bearish sentiment from rising bond yields and hawkish Federal Reserve talk about higher interest rates.
The bond rout was highly suggestive of non-Wall Street actors being involved. Reports suggest that at least $17-plus billion worth of U.S. Treasury bonds were sold in the month of September by China, Brazil, and Saudi Arabia.
The combination of the Fed’s tough talk and the unforgiving selling by the three countries named above created a sentiment environment in the financial markets which may have set the stage for yet another end of the year rally where seasonal tendencies remain bullish.
Price charts for TNX, QQQ and the New York Stock Exchange Advance Decline line suggest the worst may be over. If these trends remain in place, we are likely to see higher stock prices over the next few weeks to months.
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