The bears were surprised by a positive response to a very dovish Federal Reserve on Thursday, but they finally found an issue that caused some market concern to close out the week.
That issue is an inverted yield curve.
Typically, shorter-term interest rates are lower than longer term rates. However, when there are concerns about longer-term growth that shifts the demand for debt. People would rather borrow shorter term when they think the economy will soften longer. This causes shorter-term rates to rise faster than longer-term rates. This is why an inverted yield curve is generally viewed as an indication that a recession may be developing.
An additional problem when the yield curve inverts is that since banks tend to borrow money in the short term (in the form of deposits) and make loans on a longer-term basis, it is harder for them to make money. That is why there was such strong pressure on banks this week (The Financial Select Sector SPDR ETF (XLF) declined 4.8% over the last five days).
The market has had a few "inverted yield" curve scares in the last couple years but they were shaken off fairly quickly. The Fed can address this issue to some extent, although it has shown no inclination to do so. There are many opponents to higher longer term rates especially in the real estate industry.
The question for us to ponder is whether the problem Friday is a longer-term issue or not. There is no way to know but the weaker action should have triggered some stops and caused some defensive moves.
Even with the big drop Friday the S&P 500 was down just 0.73% for the week. What was much more troubling was the small-caps, which lost 3.3%.
Breadth was brutal Friday with 1,250 gainers to 6,000 losers. The indices are still well off their lows so the number of new 12-month lows did not expand.
The S&P 500 is still well above its 50-day simple moving average and has some support but the Russell 2000 is in much more precarious position, below its 50-day.
My theme this week has been to let your individual stocks be your guide to timing the market. When they weaken and you lose money that is the best indication that you need to take defensive action. That was the case Friday and hopefully you tightened up and played some defense.
Have a great weekend. I'll see you on Monday.
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