Bond Rally to Reverse?
Featuring Mark Newton
Published on: July 3rd, 2019 • Duration: 12 minutesMark Newton, CMT, president and founder of Newton Advisors outlines his technical take on the bond rally and reviews why he thinks yields are due for a short-term bounce. He also highlights his outlook for the S&P 500, notes why financials should head higher over the next few months, and discusses how to make the trade via a regional banking ETF, in this interview with Justine Underhill. Filmed on July 2, 2019.
JUSTINE UNDERHILL: Welcome to Real Vision's Trade Ideas. Today, we're sitting down with Mark Newton of Newton Advisors. Great to have you here.
MARK NEWTON: Thank you.
JUSTINE UNDERHILL: So, let's talk a little bit about what's going on in the markets right now. We have both stocks and bonds rallying. I'm curious as to your take on what's going on.
MARK NEWTON: It's interesting. Equities have been incredibly resilient within this environment where there's still a lot of uncertainty, what's going to happen with a trade deal or with the growing threat of a global economic slowdown. And so, equities have managed to post one of the best Junes we've seen in quite some time. And so, really, we've had five out of six months have been literally straight up this year, after only a little bit of a down May. Bond yields have gone the opposite direction, we've been obviously trending lower. That seems to be starting to stabilize a little bit with the 10-Year down near 1.95% to 2%.
My thinking is the bond market continues to have a real lack of conviction that the economy can truly grow out of this. And that means that recession likely is going to be around the corner. I don't know that it means it's right away. I think that some of this is just the demand for yield that we're seeing bund yields down at minus 30 bips and we see literally, quite a few of the sovereign yields have all gone negative. And so, the US is one of the last men standing and there's a lot of demand for Treasuries here at a time when equities have been rallying.
So, I'm more of an equity guy. And I think markets can still push higher in the months ahead, I'm still pretty optimistic between now and late August, September that S&P can push up above 3000. And get up to 3040 to 3070. Momentum is still very, very good. Breadth has been decent on the market. We're starting to see more signs of sector rotation into the good risk on sectors. Technology has made a decent snap back. Healthcare is starting to come back. Transportation, just in the last week, has begun to also show some strength and the one that we can touch on a little bit more in this conversation is financials that have started to act a lot better lately.
And so, my thinking is part of that is related to bond yields starting to reach a trough, we've gotten very oversold, and we can talk about that in a bit. But I like equities for now. And as we reached the fall, I think it'll be time to pare back a bit based on some of the intermediate term momentum starting to fall off. But it's really been right to trust this rally so far and ignore a lot of the news and a lot of the tweets and just think that the trends don't lie, and breadth has actually gotten better of late and momentum, and we're starting to see more signs of participation. So, a lot of this means that a lot of the fears are at least you'll conceive there are potentially- it certainly haven't materialized yet.
JUSTINE UNDERHILL: And speaking of financials, you've actually been fairly bullish on financials, you've been on the show a few times since fall, and you've been bullish on financials quite a few number of times. But that case was, a lot of times, was based on yields rising, but yields haven't risen over the past six months. So, what do you see going on with financials? Why have we seen a pop in financials?
MARK NEWTON: Yeah, it's interesting. It's more just in the last week, the financials have really come to life. We have seen some evidence of the 10-Year Treasury Yield going from 1.95% up to over 2% briefly, and at least technically, you're seeing signs that yields have gotten very, very oversold based on traditional metrics, really the most oversold we've seen on a daily and weekly basis since almost 2011. So, very oversold, and some evidence of counter trend exhaustion in place. My thinking is you're seeing positive momentum divergence, also with bond yields, which means that yields have dropped a little bit, but momentum is not going down any further.
So, technically, from the way I look at the world, oftentimes, that's a precursor to a decent bounce in the yields. I'm not certain that that means we go to 2.50% or 3%, I'm calling for really a move up to about two and a quarter or so between now and the fall, but I think the financials thus far have shown some really interesting signs of strength. So, technically, we look at charts of, say, the S&P financials index, or the XLF versus the S&P, we've actually broken the entire downtrend since early last February when we peaked out. So, that's interesting to me.
And that the Financial Group is really starting to strengthen at a time when bond yields really haven't rebounded that dramatically. But you're seeing it more in some of the regional banks and the brokerages are starting to do much better. And the bigger banks, it takes some time, but they're also starting to rebound as well. So, I do like the group, I think it's a good way to play the market between now and the fall. I like healthcare, but financials is an area I would concentrate in.
JUSTINE UNDERHILL: How do you see the Fed or any Fed decision in July potentially affecting regional banks, the financials overall?
MARK NEWTON: Yeah, that's a great question. Right now, the market still anticipates there's a very high likelihood the Fed cuts. I think the Fed stays in line with what the market thinks. And this group should still have a good likelihood of rallying. I think that for now, they've been put any rate cut on the back burner. If yields start to bottom out and rally like I think, then what that means is likely the economic data probably is not going to disappoint as badly if anything will start to stabilize and rally a little bit. So, I'm not certain that we're going to get a lot of rate cuts if the market continues higher with regards to equities and if bond yields technically are showing signs that they can rally. So, a strong rally in yields would mean that potentially that is put off, at least for now. Next year, I see there being a much more likely cut in yields.
JUSTINE UNDERHILL: What technicals are you looking at? And what key levels are you looking at when specifically regarding financials, as well as smaller regional banks?
MARK NEWTON: So, for regional banks, I'm looking at I think it's trading right under $53 right now for that, so for KRE. So, for me, I think it moves up to the high 50s or so which would be probably a seven to 10% move on the upside, potentially as yield rise over the next couple months. And we'll put stops certainly at 5% on the downside. But technically, it's more of just seeing a number of things come together, so financials getting less bad and starting to act a little better. So, momentum indicators, like M-A-C-D, MACD, or RSI have started to stop going down and starting to gradually bottom out and start to turn higher. You've seen crossovers in things like MACD, you're seeing countertrend evidence of exhaustion in many of the financials.
So, for me, those are all important. And the bottom line is the charts have actually gotten a lot better in the group in the last two months, regardless of the fact that yields are still pretty low.
JUSTINE UNDERHILL: If yields don't bottom out, if they do continue to head lower, how do you see that potentially affecting this trade?
MARK NEWTON: Well, right now, the group, I do think it's going to be a temporary balance. I don't think that means the financials are going to be the next group to be in for the next few years. I think yields are going to remain low. And part of that, particularly in the next year, that there could be signs of a lot of these dire forecasts potentially becoming reality. The tariffs is something that certainly affects perception, regardless of whether it affects things in a real basis. And so, I think a lot you've seen a lot of evidence of people pulling back and just the uncertainty, which I don't believe is going away anytime soon.
So, a deal with China or that would certainly be something the market likely hasn't priced in, but if yields stay low, then financials, likely are not going to be the right place to be. So, I'll use a 5% stop and say, I guess the technical's wrong. For now, I'm willing to trust the charts. And the yields have gotten so stretched to the downside that it really makes sense to consider betting against Treasuries and we're going to get a decent rebound.
JUSTINE UNDERHILL: So, just to play devil's advocate here, you've been looking for a bounce in yields several different times over the past year. Why do you think this time is different?
MARK NEWTON: This time is different, because technically, what I look at has gotten far more extreme in terms of getting to almost levels that- extremely oversold levels with regard to yields, and I'm getting a confluence of that with positive momentum divergence, and also some exhaustion in some of the indicators that I look at the market. Indicators have turned up signs of exhaustion for the first time on a daily and a weekly basis, really the entire year. So, yes, it is proper to pick your spots, and tactically, one can do that and have stops and you're wrong, I think I have a little bit more conviction this time than I think where yields should start to bounce from here.
So, I can use 1.90 as a level of stopping that out and think that we have probably five to 10 basis points in the downside of risk there. And really on the upside, yeah, you could get 25 or 30 or more. But a lot of that does depend on the economy turning out to be much better than people think right now, and then a lot of this uncertainty goes away. And that also helps sentiment to turn a lot more optimistic, which I think probably should happen into the fall, which in turn will proceed to fall peak in the market.
JUSTINE UNDERHILL: All right. Can you summarize your trade thesis for stocks, for bonds, and specifically for financials in 30 seconds?
MARK NEWTON: Yeah. I like the market to continue moving higher between now and mid-August, or potentially even as high as mid-September of this year. I think S&P goes from current levels right around 2965 up to about 3040 to 3075. So, not a whole lot more upside about 100 points. The way I play it for now is take advantage of this recent momentum that we've seen in the financial space. I think we've seen decent breakouts in things like KRE and XLF, and particularly regional banks in relative terms.
So, I'd be long regional banks that are priced right near 50 to 85, for move to the high 50s would stop that out, we can use 4% or so on the downside. So, really, right near $50 will probably stop out any long on KRE. Interest rates, I think we're going to bounce from where we are 2% up to about two and a quarter. And that should probably be a chance to consider going the other way again. It's very necessary to have a tactical view in this market. It's tough to look out three to five years and have a trade that's just going to go in one direction that starts today. So, there's going to be a few moves in different directions. But that's a summary.
JUSTINE UNDERHILL: Well, I appreciate your short term outlook. Mark, thank you so much.
MARK NEWTON: My pleasure. Thanks for having me, Justine.
JUSTINE UNDERHILL: So, Mark is bullish on financials. Specifically, he likes buying the regional banking ETF ticker symbol KRE at 53 with a 5% stop loss and a target price in the high 50s over the next three months. Just remember this is a trade idea and not investment advice. Make sure to do your own research, consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.