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Rising sovereign bond yields do not signal medium-term top for stock indices

market relief

It was a muted start for the US stock market yesterday as it reopened for the week. The S&P 500 and Nasdaq 100 recorded minor losses of -0.09% and -0.25% respectively after both hit fresh all-time highs last week. The lesser big tech weighted Dow Jonesmanaged to squeeze out a gain of +0.20% to 31,522, another new all-time high close. Meanwhile, the small-cap concentrated Russell 2000 underperformed as it shed -0.72% to 2,272 after an accumulated gain of 10.4% since 29 January.

The main catalyst for the outperformance of the Dow against its peers has been the rising US Treasury 10-year yield since its medium-term swing low of 4 August 2020 at 0.50%. At the close of yesterday’s US session, the 10-year yield increased by 10 basis points to 1.30%, which has surpassed March 2020 high of 1.28% and right now it is just flirting right below a major resistance of 1.37%.

The ongoing rising US Treasury 10-year yield has led to an increase in the 2-10 US Treasury yield spread to hit 1.18, a level that was not seen since February 2017 where such observation tends to benefit cyclical sensitive stocks such as financials/banks and commodities related. As seen in yesterday’s performance of the 11 S&P sectors, Energy (+2.26%) and Financials (+1.77%) took leadership position while the Health Care (-1.02%), Real Estate (-1.07%) and Utilities (-1.14%) underperformed.

Interestingly, semiconductors stocks, a proxy for global growth has outperformed within the Information Technology sector (-0.30%) where the iShares PHLX Semiconductor ETF (SOXX) gained by +0.50% to 439.36, a new all-time high. Hence, yesterday’s performance seen in the SOXX, Energy and Financials stocks do not indicate a clear signal that the medium-term uptrend of the major US stock indices have ended.

Another observation that is worth to take caution in the short to medium-term will be in the electric vehicle (EV) space where EV related stocks have recorded astronomical gains in the past six months that sucked in significant inflows as market participants chase momentum and the current hype in the green energy (part of ESG) theme reinforced by its embrace from the US administration and other developed countries such as China. However in the past two weeks, leading EV stocks have turned “soft” where daily losses were recorded at end of yesterday’s US session for Tesla (-2.44%), Xpeng (-4.01%), Li Auto (-4.55%) and Nio (-1.04%). In addition, relative strength Tesla against the S&P 500 have deteriorated since 8 February which indicates underperformance of Tesla versus its benchmark S&P 500. Therefore, these EV stocks are now facing an increasing risk of a potential -15% to -20% corrective decline as a negative feedback loop can be triggered easily due to its inherent overstretched optimism on their respective future share prices.