Will a Hot CPI Report Widen the Gap in This Two-Tier Market?
Bonds are improving, but the stocks that should benefit aren’t responding.
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Interest rates are the focus Wednesday morning as we await the September consumer price index. The bond market has been calming down after a punishing September selloff, but the bounce in bonds hasn’t done much for the stocks that should benefit most.
The yield on the 30-year Treasury bond fell Tuesday for the third session in a row, its first such streak since early August. Some of the issues that caused the September selloff are easing. Investors who hold mortgage bonds, for example, have less need to sell Treasuries to protect themselves against rising rates. Some investors also see a buying opportunity after yields hit their highest levels in 24 years, arguing that the market has overestimated how much more the Fed will raise rates.
New York Fed President John Williams gave the more dovish view some support Tuesday, telling Bloomberg that the economy could evolve in a way that means the Fed doesn’t have to raise rates next year. That contrasts with Fed Governor Christopher Waller, who said last week that more hikes are needed.
Lower Rates Aren’t Helping Small-Caps
Lower interest rates should help smaller stocks, which rising rates have hit hardest. That isn’t happening. Bonds rallied Tuesday, and the iShares Russell 2000 ETF (IWM) still slipped back to its 200-day moving average while new lows topped 500. The SPDR S&P Biotech ETF (XBI) is typically sensitive to interest rates because many of its companies need capital, but hedge-fund degrossing has also weighed on the group.
The rotation in this market runs in two directions. Interest rates are moving money between the AI leaders and the rest of the market, and money is also rotating inside AI. The hyperscalers are leading, while chips and AI infrastructure names are under pressure.
On Tuesday, comments by CXMT, one of China’s biggest memory chip makers, sparked fears of Chinese competition, and Micron Technology (MU) and other U.S. memory stocks slumped. The hyperscalers benefit from that kind of competition. More suppliers competing for their business means lower chip and data center costs.
The Irony of CPI
Economists surveyed by The Wall Street Journal expect September CPI to be 3.6% annually, up from 3.4% in August. Excluding food and energy, the figure is expected at 2.5%, up from 2.4%.
The Fed raised rates last month for the first time in three years, and most officials expect one more increase this year. Strong consumer spending and the data center boom, which is pushing up the prices of chips and other goods, are both keeping inflation above the Fed’s target.
The irony is that a hot number would probably help the Magnificent Seven names and hurt the rest of the market. Higher rates would put pressure on secondary stocks already struggling, while reinforcing the mega-caps’ status as a safe haven. A bad inflation report could widen the gap even further.
The rest of the market needs a cooler number. But after Tuesday, when lower yields did nothing for small-caps, I’m not convinced that a good number alone will be enough.
Game Plan
Whether the gap between the two tiers of this market starts to close is the single most important issue right now. I’m less focused on the CPI number itself than on how the secondary stocks react to it. If they can rally on good news, it would be the first sign in a while that the gap may be starting to close.
I would love to put more capital to work, but until I see better technical action, I’m staying patient and keeping my buying small.
At the time of publication, Rev Shark had no positions in any securities mentioned.
