MW Here's the biggest threat to the bull market, according to one strategist

By Steve Goldstein

Higher real rates in Japan could deflate U.S. tech bubble - or vice versa, a strategist says

U.S. stocks had their third day of losses in succession on Wednesday as Treasury yields advanced. Earlier in the week, technical analysts at brokerage Strategas said equities have tended to consolidate following 3-month highs in real yields. On Wednesday, the 10-year Treasury inflation-protected securities yield closed at 1.93% - the highest in nearly 3 months.

Granted, consolidation isn't the worst thing in the world with the S&P 500 index SPX up 22% this year. The larger question is how long the bull market can continue.

Dhaval Joshi, chief strategist of BCA Research's Counterpoint, says the biggest threat to the U.S. bull market comes from Japan.

That of course brings to mind the wobble in August, when U.S. stocks, in particular those in the technology sector, slumped as the yen surged. But those fears about the end of the carry trade in the currency have totally evaporated - the dollar $(USDJPY.FOREX)$ is up 9% from its mid-September lows, and the Nasdaq 100 ETF QQQ has gained 12% from Aug. 5.

Joshi points out Japan's inflation-adjusted policy interest rate now stands at negative 2.3%, and there's a huge 5.4% gap between that and the U.S. Since 2022, he notes, Japan's real rate differential with the U.S. has dropped 12 percentage points. "For the real policy interest rate differential between two major economies to change by so much in such a short space of time is an unprecedented extreme," he says.

Joshi says Japan's deeply negative real rate has fueled what he calls a bubble in AI stocks. He charts the strong correlation between U.S. tech valuations and the dollar vs. the yen. While people remember the late July/early August episode - fueled by a hawkish Bank of Japan announcement and a weak U.S. jobs report - he also notes what happened after the strong jobs report released on Oct. 4.

"As U.S. rate cut expectations got pared back, U.S. bond prices fell. Paradoxically though, U.S. tech valuations re-inflated. The reason being that, in a mirror image to what followed the Aug. 2 jobs report, real rates in Japan versus the U.S. became more negative again, reigniting flows into U.S. tech, funded by yen borrowing," he says.

Joshi says that leads to three conclusions. One is that if deeply negative yen rates versus the U.S. are unsustainable, then so is yen weakness. Another is that a long yen position is an excellent hedge for U.S. tech stock weakness.

Crucially, the causality could run either way. Higher real rates in Japan vs. the U.S. could deflate U.S. stocks, but also, a puncturing of the hopes around artificial intelligence would unwind yen-funded exposure to U.S. tech, boosting the Japanese currency.

And finally, he recommends overweighting U.S. small caps IWM vs. U.S. tech stocks.

The markets

The major stock index futures contracts rose (ES00) (NQ00) early Thursday though the Dow industrials (YM00)was left behind, dragged down by about a 100-point headwind from IBM and to a lesser extent Boeing. Gold (GC00) rose and U.S. Treasury yields BX:TMUBMUSD10Y fell.

   Key asset performance                                                Last       5d      1m     YTD     1y 
   S&P 500                                                              5797.42    -0.77%  1.31%  21.54%  38.47% 
   Nasdaq Composite                                                     18,276.65  -0.49%  1.08%  21.75%  42.55% 
   10-year Treasury                                                     4.2        10.40   40.00  31.91   -64.87 
   Gold                                                                 2749       1.50%   2.00%  32.69%  37.79% 
   Oil                                                                  72.22      2.06%   7.06%  1.25%   -13.51% 
   Data: MarketWatch. Treasury yields change expressed in basis points 

The buzz

Tesla $(TSLA)$ stock jumped as the company's margins were surprisingly strong in the third quarter.

IBM $(IBM)$ stock by contrast fell as the company's revenue came up short of expectations.

Boeing $(BA)$ shares fell 3% after workers rejected a pay pact, prolonging a damaging strike at the planemaker.

Shares of Seadrill $(SDRL)$ rallied after a report the offshore drilling company is in talks to merge with Transocean $(RIG)$.

U.S. weekly jobless claims, flash purchasing managers indexes and new-home sales are on the economics calendar for Thursday.

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The chart

A report from Bloomberg that the U.S. asked Group of Seven allies to sanction Russian-produced palladium lifted the hard-hit metal (PA00). Russia accounts for about 40% of global supplies. Ole Hansen, head of commodity strategy at Saxo Bank, said the development may further rattle a long-held speculative short while raising supply anxiety as well.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

   Ticker  Security name 
   TSLA    Tesla 
   NVDA    Nvidia 
   DJT     Trump Media & Technology 
   GME     GameStop 
   TSM     Taiwan Semiconductor Manufacturing 
   AAPL    Apple 
   NIO     Nio 
   PLTR    Palantir Technologies 
   PHUN    Phunware 
   AMZN    Amazon.com 

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-Steve Goldstein

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October 24, 2024 06:24 ET (10:24 GMT)

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