Stocks post worst day of 2023 as rising interest rates contribute to ‘perfect storm’

Since the start of the month, traders in fed-funds futures have been pricing in a more aggressive Federal Reserve after initially doubting whether the central bank will meet its forecast for a spike above 5%. Some traders are now even pricing in the external possibility of a peak rate close to 6%.

The yield on the 2-year Treasury bill

TMUBMUSD02Y

jumped 10.8 basis points to 4.729%, the highest result of a US session since July 24, 2007.

TMUBMUSD10Y

climbed 12.6 basis points to 3.953%, the highest since Nov. 9.

“At this point, the bond market has all but abandoned optimistic expectations for limited further hikes and a series of rate cuts in the second half of 2023,” said Daniel Berkowitz, director of investment for Prudent Management Associates, in an emailed commentary.

Meanwhile, the US dollar has also rallied, with the ICE US Dollar Index contributing 0.2% to a February rally. Arbeter also noted that breadth indicators, a measure of the number of stocks participating in a rally, had previously deteriorated, with some readings reaching oversold levels.

“Just another perfect short-term stock market storm,” Arbeter wrote.

Rising returns can be negative for equities, increasing borrowing costs. More importantly, higher Treasury yields mean that the present value of future earnings and cash flow are more heavily discounted. That could weigh heavily on tech and other so-called growth stocks whose valuations are based on earnings well into the future. Those stocks took a beating last year but led to gains during an early 2023 rally and remained resilient over the past week even as yields extended an uptick.

Yields have risen after a run of hotter-than-expected economic data, which fueled expectations for rate hikes by the Fed.

Meanwhile, weak guidance Tuesday from Home Depot Inc.

HD

and Walmart Inc.

WMT

also contributed to the weak stock market tone.

Home Depot fell more than 7% making it the biggest loser among the components of the Dow Jones Industrial Average

DJIA

.
The drop came after the home improvement retailer reported a surprise drop in same-store sales in Q4, led to a surprise drop in profit in fiscal year 2023 and earmarked an additional $1 billion to pay its employees more.

“While Wall Street expects resilient consumers following last week’s robust retail sales report, Home Depot and Walmart are much more cautious,” Jose Torres, senior economist at Interactive Brokers, said in a note.

“This morning’s data is sending more mixed signals on consumer demand, but during a traditionally weak seasonal trading period, investors are shifting to a glass half empty against the backdrop of a year that so far has featured the exact opposite, glass half full perspective,” he wrote.

The Dow fell 697.10 points, or 2.1%, to close at 33,129.59, while the S&P 500

SPX

fell 2% to 3,997.34, ending below the 4,000 level for the first time since Jan. 20. The decline reduced the S&P 500’s gains so far to 4.1%, according to FactSet, which is less than half of the 9% year-to-date gains it had enjoyed at its February 2 peak.

The Nasdaq Composite

COMP

fell 2.5%, dragging year-to-date earnings to 9.8%. Due to the losses, the Dow remained slightly negative this year, down 0.5%. It was the worst day for all three major indices since December 15, according to Dow Jones Market Data.

Arbeter identified a “very interesting cluster” of support just below Tuesday’s low for the S&P 500, with the convergence of a few trendlines along with the index’s 50- and 200-day moving averages, all near 3,970 ( see chart below).

“If that zone does not represent the pullback lows, we have more trouble ahead,” he wrote.