This stock market rally has some staying power but there’s one big obstacle

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Stocks bounced off bad news on inflation last week and have been rising in the kind of broad-based rally that suggests the move higher could endure. But the surge in stock prices has also been accompanied by higher bond yields, and that worries strategists who follow stock charts. The closely watched 10-year yield has been hovering around 4% and was trading above that at 4.03% at midday Tuesday. Yields move opposite price. As yields rose from just under 4% Tuesday morning, the stock market rally lost some steam. “There’s a lot of wood to chop for this market to get back and start functioning,” said Mark Newton, head of technical strategy at Fundstrat. “First and foremost, we need to see rates roll over a bit.” Newton said he expects stocks could rally between October and December, but his work shows the market may then have a retest and possible break of the recent lows in the second quarter of next year. He said for now, in order for a conviction low to be in place, the S & P 500 needs to rise above 3,820. The S & P 500 was at 3,721 at midday, off an intraday high of 3,762. “I think the bond market needs to bottom right away to give me a little conviction there because the correlation has been very strong,” said Newton. “There’s a period of October, in the next week, that historically has been negative. In general, I think that after Nov. 10, you have a little more reason to expect that rallies can extend.” Newton said there are some key events on the horizon, including the next Federal Reserve meeting Nov. 1 and 2; the midterm election Nov. 8 and the next consumer price index release Nov. 10. He said eventually data will begin to show inflation is ebbing, and that will be a positive for the market. Hot inflation data last week sparked the reversal, and strategists say when the market rallies off of negative news, it may be signaling a bottom. September CPI last Thursday showed inflation running at a still high 8.2% on an annual basis . Newton said he expects the 10-year yield to come off its highs and move toward 3.5%. That should help stocks rally into year end, but he expects the yield to rise again next year, challenging the market. Oppenheimer technical strategist Ari Wald said he would like to see the 10-year yield retreat to 3.5%, a key level for stocks. But he is encouraged by the strength of the rally and says there’s a chance this could be the start of a new bull market. “Generally speaking, there’s going to be pockets of growth and value that work,” he said. “We do expect to see pockets in tech do well in this upturn. There’s some good opportunities here. We want to be open in time horizon. Until rates start to turn lower, there’s a lingering risk for those areas.” Even as rates remain high, the stock market is sending positive signals, Wald said, including the rally in small caps and the improved breadth as more stocks participate. “You could always side conservatively and assume it’s a bear market rally,” he said. “I want to be open to an upturn in the cycle here because from our analysis, the criteria has be filled. … We based and now we’re turning at a time of year where we would typically turn. I think the set up is there for, at the least, additional countertrend move into year end.” BTIG’s technical strategist Jonathan Krinsky points out that even when tech and growth stocks bounced Monday, the bond market traded poorly. He pointed to action in the iShares 20+ Year Treasury ETF , which set a fresh year-to-date low Monday. Nasdaq’s surge Monday resulted in a rare 3% inside day, he said. That means Nasdaq rose 3% but was still within the range of Friday’s session. “We think the recent action is telling and has tended to occur in the midst of bear markets more than the start of new bulls,” he said. Krinsky noted that there were nine instances of 3% inside days when the Nasdaq 100 was below its 200-day moving average. The index averaged a steep 7.2% decline 20 days after those occurrences. “We don’t think we are at the final end of this bear market, and therefore would be inclined to fade this rally,” he wrote in a note. In the short-term, some technical strategists are eyeing 3,900 on the S & P 500. “The first obstacle is closer to 3,800 but ultimately it does look like 3,900 could happen in the weeks ahead with a few little things going right,” said Scott Redler, partner with T3Live.com. Redler said earnings need to be supportive, even if results are mediocre. Redler said he is watching a formation in the daily S & P 500 chart, which signals an inverse head and shoulders, a positive. But he is also watching the market day-to-day, and expects it is in a bear market rally, rather than a new bull trend. Redler, who watches short-term technicals, said he trimmed some of his long positions after Monday’s rally. He said he is watching Netflix and Tesla , which report earnings after the bell Tuesday and Wednesday, respectively. “If Netflix underdelivers, it would be a setback for this rally,” he said. “Tesla has fallen from $305 less than a month ago and it hit a low of $206. The bar isn’t as high as it was in past earnings seasons.” Newton said he is not so concerned by earnings. “Stocks don’t care about earnings all that much,” he said. “Since 1932, corporate profits were down in 19 years, and the S & P 500 rose in 14 of those.” Many strategists expect further reductions in earnings forecasts and expect that could be problematic for stocks. But Newton points out that rates specifically drove the market lower in January. “When rates peaked in June, that’s when the market bottomed. Stocks are very tied to Treasurys now, and it’s necessary for rates to roll over,” he said, adding the strong dollar is also an issue for equities. Wald said the rising yield is the “lingering non-confirmation” of the rally. “That could continue to pressure some of those growth areas that have been hardest hit,” Wald said. “Our feeling is the breadth of stocks have bottomed particularly those with less rate sensitivity.”

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