by Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company
Week 3 of the conflict in Iran took equities to new lows and bond yields to new highs. The S&P 500 index is now down 7.6% from its highs, while the 10-year yield has spiked to 4.39%. The longer the Hormuz Strait remains closed the more stagflation is getting priced into the capital markets, not just in the US but across the globe. Last week was noteworthy because on Friday two of the steadfast towers in the market – the Mag 7 and gold – started to lean. Losses were widespread across the asset class spectrum, save for the dollar, energy commodities and equities, cash, and yes, Bitcoin. The markets are pricing in a long-term inflation shock, and with it, the end of monetary policy accommodation. Fortunately, a strong earnings cycle has prevented the price indices from falling as much as valuations, which are down 20% in the US. Let’s review the data.
Heatmaps
In the table below, we see that the drawdown in the S&P 500 has now reached 7.6%, with breadth reaching moderately oversold levels. That drawdown masks a far bigger decline in valuations, with the trailing P/E down 20%. The MSCI EAFE and EM indices are down around 10% each. For the S&P 500 the percentage of stocks above their 50-day moving average is down to 20%, and the percentage above their 200-day is 45%. For the former, at major oversold extremes that number often falls into the single digits. We are not there yet, but seem to be getting closer to a selling climax.
While crude oil prices did not make new highs last week, brent remained at triple digits ($119) while WTI ended the week at $98. The crude curve remained backwardated, suggesting that the oil market does not expect the stoppage to last more than a few months. Gold took a giant tumble on Friday, back to the recent range lows at $4,500 (down $1,100 from the high), while Bitcoin continued to show remarkable resiliency by holding at $70k. This has been one of the major signals over the past 3 weeks. Gold is -27% correlated to the dollar while Bitcoin is +64% correlated. That suggests a lot.
Most of the fireworks last week actually occurred in the bond market. While credit stress in the SaaS-heavy private credit markets stabilized, the stress moved over to the long end of the yield curve. Both inflation expectations and real yields moved higher last week, with the 5-year TIPS break-even reaching 2.70% and the 10-year real TIPS yield reaching 1.99%.
MOVE over VIX
In the chart below we can see that the MOVE index (bond market implied vol) shot up and took over as the fastest moving metric.
The drawdown in the S&P 500 reached 7.6% last week, which is not that big a deal (so far) by historical standards. Robust earnings growth is masking what would otherwise be a much larger correction.
The drawdown in the S&P 500 reached 7.6% last week, which is not that big a deal (so far) by historical standards. Robust earnings growth is masking what would otherwise be a much larger correction.
Crude realities
While WTI has remained just under $100barrel, Brent has remained well above $100 as it is more dependent on the Strait. Per the bottom panel below, the backwardation of the forward curve has continued to sit around $20/barrel as the Strait remans more or less closed.
Rates & the Fed
Long yields broke out last week and finished the week at 4.39%. As I have written many times, nothing good happens above 4.5% when the risk-free rate is competitive with risky assets, as is now the case.
Rising Yields
While the 10-year yield broke out of a short term range, the weekly chart below still shows bonds holding within a long triangle (in place since 2022). If it breaks, it will be a problem not only for bonds but equities and other assets as well.
Global reset
It may be tempting to think that the rise in yields is the product of a US-centric dynamic (relating to OPEC recycling no/fewer petrodollars into Treasuries), but the next chart shows that yields are rising everywhere. This is global reset, not unlike 2022.
Earnings & Valuation
If that reset continues, we could get a 2022 “echo,” in which equities correct entirely on the basis of falling P/E’s, while earnings continue to grow. Remember that stock prices are driven not only by earnings and payouts but also interest rates and the equity risk premium. So far, the S&P 500 price index is down 7.6% but the P/E ratio is down 20%. If earnings were not growing double digits right now, we would be looking at much greater drawdowns.
We can see this phenomenon in the chart below, which shows what “share” of the market’s return has come from multiple expansion. That share is falling while the share from earnings and dividends is rising. That’s painful over the short-term but healthy over the long-term.
Breadth & Concentration
Technically, both the cap-weighted and equal-weighted indices remain in their cyclical bull markets, which started some 41 months ago in October 2022. We still have higher highs and higher lows, which are the very definition of an uptrend. Both indices are now at or below their post-2022 regression trendlines.
We can see below that the equal-weighted index has now reached support in the form of the 2025 high.
Leaning Towers
Last week the Mag 7 broke below its well-defined trading range, which had been in place since last October. As I have often written, in a concentrated market, as go the mega caps, so goes the index. That is now happening.
Earnings support for the M7
The Mag 7 has continued to be supported by strong earnings growth, and in the chart below one could make a compelling case that the M7 have corrected enough, as the price index has gone from hugging the earnings forecast for year 3 to the earnings forecast for year 1 (next 12 months). And if the drawdown does get worse in the coming days or weeks it could make the Mag 7 that much more attractive fundamentally.
No AI bubble
The Mag 7 notwithstanding, the AI playbook (led by memory stocks and data centers, with software lagging behind) has not been materially impacted by the stress in the broader market. To me this strongly suggests that the AI boom continues to be a boom and not a bubble. If it was a bubble, the fast money likely would have bolted by now as risk appetites fade.
Gold & Bitcoin
Gold took a major hit on Friday and is now at support at the $4,500 area. That seems like a good entry point to me, if this correction pattern continues a long series of stair-steps higher.
And Bitcoin continued to hold in there like a champ, not even breaking $70k last week. This looks like the stuff that basing patterns and emerging bull markets are made of. As of this writing (Sunday morning) Bitcoin as of the weekend risk-on/risk-off proxy has dipped below $70k, but in my opinion even a dip back into the mid-60’s will not change the resilient price action.
Conclusion
With stocks and bonds positively correlated again (but in the wrong direction), there’s a bit of 2022 déjà vu right now. Back in 2022 as the cost of capital reset after years of ultra-low rates, the 60/40 model broke down and a 60/20/20 model (or some variation thereof) rose from the ashes. To me, interest rate and concentration risk remain big risks worth mitigating, and last week we got a taste of why. In my view gold remains in a structural bull market and is attractive here at $4,500. Bitcoin is also in a super cycle and appears to be doing the right things after its mild winter to $60k. As always, I think a “hard money” bucket can contain both. And equities will become more attractive the further they correct, supported by positive earnings growth and now cheaper valuations. Nobody likes corrections but they can produce opportunities to rebalance, as this one will do sooner or later. For some, it may be time to be the liquidity provider, not the taker.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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