It might feel like it now, but the traditional portfolio comprising 60% stocks and 40% bonds isn't dead.
We're coming from three years of financial market chaos. Some of it was induced by black swan events (first Covid, then the Russian invasion of Ukraine), but much of it is self-induced. There is plenty of blame to go around for the dysfunction we're currently experiencing in stocks, bonds, and especially commodities.
For instance, the Federal Reserve stimulated too much for too long; politicians also voted in big spending bills to keep the spigots flowing, and market participants drank the Kool-Aid believing risk assets were something other than risky. Aggressive speculation, and the liquidation of those positions, has led to price distortions across the board for much of the last three years.
However, we believe the markets are normalizing. We are starting to see correlations between asset classes decouple. This is good news. During times of market stress and investor panic, assets begin moving as if they are one asset. As markets get back to a more "business as usual" environment, each asset begins trading independent of the others and, eventually, in line with that asset's fundamental environment, as it should.
Further evidence of normalization is the fact that with interest rates approaching the fall highs, stocks are nowhere near the fall lows. This suggests equity investors have accepted higher interest rates and are comfortable with them. This could change if the Fed surprises the market in upcoming meetings, but with the bond market doing the heavy lifting for the Fed, there really isn't a need for the same type of shock-and-awe policy and jawboning we saw in 2023.
Chart Source: QST
Lastly, the U.S. dollar index has moderately recovered from what was a historic selloff, but we think it is capped near 106.00 (based on weekly chart resistance). If that is the case, it supports the idea of an everything rally as financial and commodity markets adjust to currency valuations.
In other words, if the parabolic dollar rally is in fact, in the rear-view mirror, Treasuries are a bargain, and stocks probably have some sort of floor underneath them.
Treasuries
Just like high commodity prices are the cure for high commodity prices, high yields will eventually be the cure for high yields. Although investors are clamoring into the short end of the curve, we suspect investment dollars will be comfortable going into the middle and long end of the curve in the coming weeks.
The 30-year bond future is trading in an expanding wedge pattern with support looming in the March contract near 121'0. It might not seem likely now, but there is reason to believe the long bond futures contract returns to the top of the technical pattern in the mid-130's.
Speculators hold one of the largest net short 30-year bond futures positions in history. This tells us most of the selling has probably already occurred.
Chart Source: QST
E-mini S&P 500
We are all painfully aware of the bearish headlines and narrative. It is hard to find good news out there. But if market participants have already priced in most of the bad news, we might not need positive fundamentals to see prices increase.
In fact, according to the COT Report issued by the CFTC (which is delayed several weeks due to a cyber event), the net short position held by speculators is one of the largest in the last decade. Previous occasions saw the S&P 500 rally to climb the wall of worry.
Chart Source: Barchart
According to the weekly chart of the E-mini S&P 500, the February breakout above the downtrend line hasn't failed. The trendline, which previously acted as resistance and will now act as support, lies at 3900. If this level fails, the overall uptrend pivot line support comes in at 3850. So there is a good chance that some buyers will step in near these critical technical levels. If so, a long-term trend change is still in play.
Chart Source: QST
Bottom Line
We are probably entering a period of lower volatility, which means lower risk asset returns. But long-term investors will likely see opportunities in a diversified 60/40 type allocation despite the short-run turbulence needed to overcome sins of the past. If so, the S&P 500 and Treasuries will benefit from sidelined money coming into the market.
