Will Rising Rates Derail the Stock Market Rally?

by Options Sensei |

Stocks are starting this holiday-shortened week right where they left off, going inexorably higher!  With all the major positives still in place — Covid cases rapidly declining, a huge fiscal stimulus package in the works, strong corporate profits, and an accommodative Federal Reserve — there’s no reason to believe that it won’t continue for the foreseeable future. 

However, and there is always a but, the one thing that could cause stocks to stumble is rising interest rates. 

With my Options360 Service having a bullish position in iShares 20+ Treasury Bond (TLT), I’m keeping a keen eye on the bond market. Yields have been trending higher for the past few weeks with the 10-Year Note hitting 1.27% on Tuesday — the highest level since the Pandemic hit over a year ago.  This could be a key inflection point resulting in a stalling stock market. 

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People have been calling for inflation for years due to increased money supply as the Fed floods the market with liquidity.  But, this is the first time seeing price pressure as supply chain disruptions combined with increasing consumer demand as global economies rebound, driving up commodity prices and finished products.     

Treasuries are yielding more than the S&P 500 Index dividend yield

For the first time since the pandemic, treasuries are yielding more than the S&P 500 Index (SPY) dividend yield (10 and 20-Year Treasury yields, 1.27% and 1.85% respectively) while the S&P 500’s current dividend yield at 1.47%). This is notable because there was only one other occasion where long-dated bonds yielded less than the SPY, which was during the financial crisis of 2008. 

s&p 500 30 year treasury bond

This could prove crucial as institutional money managers, especially starving-for-yield pension funds, look to lock in a positive risk-free rate of return. Additionally, many funds will have basic allocations mandates.  With quarterly rebalancing coming due, this rate rise comes at an opportune time.  

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Also, in a zero environment, valuations were becoming unanchored, as rates rise high, p/e multiples will come under pressure.  At midday on Tuesday, we were already seeing the Invesco Nasdaq 100 (QQQ) reverse earlier gains and turn negative.  

I don’t think any major sell-off coming

I don’t think any major sell-off coming. However, it would be a welcome development for the market to lose some steam.  The Options360 Service continues to hold bullish positions in names such as Wal-Mart (WMT), and Morgan Stanely (MS),  among others. But, I’ve been finding it increasingly difficult to add additional bullish positions at ever-higher prices.  

So, for now, the Options360 Service is patiently waiting and seeing how the next few days play out, with expectations for more attractive setups.

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