Despite the gloomy headlines the market received this summer, major stock market sectors are showing resilience across the board, with new signs of life emerging.
A shift seems to be on the horizon.
At the moment, we are long bonds. We like bonds, and the charts tell us we are right to like bonds here, but what does the future hold?
If inflation starts ticking up again, the market usually pivots toward the reflation trade—favoring sectors like energy, small caps, and financials as rates rise. (I am not saying that this is happening. I am saying that we need to keep an eye on this.)
Energy has not participated in the bull run this year. When we compare XLE to some of the best stocks this cycle, like XLK, the performance gap is wild.
The chart below shows XLK up roughly 40% over the trailing 12 months while XLE is negative.
Meanwhile, the rally in bonds appears to be slowing down.
Bonds have a traditionally inverse relationship with energy stocks, so we think this further sets the stage for a catch-up trade from oil and gas.
Oil, which is highly correlated with energy stocks, hasn't shown signs of a reversal yet, but it’s holding at a major support zone, while bond yields are starting to rebound.
The chart above illustrates just how closely oil prices follow the 10 year yield.
According to seasonal trends, rotation into energy typically unfolds within the next month or two—if it's going to happen at all. As traders, it's crucial to keep an eye on what's coming next.
It's a familiar pattern for bond yields to dip during the summer, particularly in election years, before rising again in the fall. The U.S. 10-year yield tends to climb in autumn, and this trend is even more pronounced in election cycles.
When this happens, we could see a shift towards the reflation trade, something we haven’t seen since November 2020, which was also an election year.
This year, market rotations have occurred earlier than usual. There was a move into small caps in July, a time when the market typically experiences volatility, and small caps tend to bottom in October.
In times like these, it’s important to stay vigilant about what’s ahead.
With the Fed cutting rates and inflation quietly lingering in the background, oil prices warrant attention. While we're happily maintaining our long bond position, it's crucial to recognize the risks. Energy markets may start to anticipate that rate cuts could stoke inflationary pressures, and being prepared for that possibility is key to managing our exposure effectively.
The first ASC Mastermind class took place yesterday, where JC discussed how to define personal objectives and manage risk as both a trader and investor. Tomorrow afternoon, we’re releasing a special ASC Mastermind Lab Course. You can access yesterday’s session and all future courses here.
As always, be sure to download this week’s Bond Report!
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