In previous commentaries we have discussed how markets drive narratives and not the other way around. But that doesn't stop many investors from trying to force narratives on markets anyway. Currently, investors are looking for a reason to continue buying into this run that we have seen over the first half of the year, but over the last month stocks have been failing to truly break out higher. We are seeing a classic example of what running into overhead supply looks like. The story goes like this. Stocks go up and attract more and more attention and buyers until a time when they start to decline. They decline for an extended time. But throughout this decline investors who bought in late near the top are unwilling to sell at a loss. So, they hold. And they continue to hold through the next market rally but remain worried and pessimistic throughout the entire rally. When their stock gets near the original price the investor paid, they get antsy and want to relieve their loss anxiety. Suddenly, there is a large supply of stock ready to be sold. This is overhead supply, and we are seeing it in semiconductors (even though Nvidia continues to rip higher), homebuilders, technology, and industrials. All these sectors are stuck just below their previous cycle highs. These previous investors are unwilling to buy back in until they see good reason to do so. To go along with this, greater numbers of people are often sellers this time of year anyway.
In many years we see markets pause or decline in the fall, and seasonally it makes sense. As one market strategist put it, people party all summer and the bill comes due in the fall. As do the bills for tuition payments, home repairs for winterization, and all sorts of things that may have been put off during summer vacations. On the flip side is the year-end rally that often follows this market swoon. Investors don’t like to be on the sideline forever and sometimes it doesn't take much to remind them of all the reasons they wanted to own that stock or index in the first place. We don’t know what the narrative will be that will accompany the next market move higher, but we can take an educated guess on what might actually be the reason.
Markets ripped higher two days ago coinciding with the largest move lower in interest rates since early June. It’s news to no one that interest rates are very high right now. Mortgage rates are around 7.25%, credit cards are near 30%, and on down the line. Everything is more expensive, especially the cost of money. Currently, there is the largest open short interest on bonds in history. Translation, people think rates will continue to go higher. However, this is historically speaking a very powerful contra indicator. All of these “shorts” are guaranteed buyers that will have to drive interest rates lower. If and when that happens, stocks will have their day in the sun again and break out to new highs.