Wall Street week ahead: Surge in bond yields, China’s economic crisis leave US stocks vulnerable

The optimism among the US investors seems to be fading away in the second half of 2023 with markets transforming from upside to more neutral areas. The recent surge in bond yields and uncertainties of China’s economic crisis is creating vulnerabilities in the equity market. As per the news agency Reuters, the pessimistic mood in the market can push investors watching contrarian indicators to buy.

At the beginning of the year, the markets showed extreme bearishness as indicated by the stock positions of investors and allocations to cash. But, with time the risk appetite of the investors increased with signs of resilience in the economy and cooling inflation. The optimism went high and took S&P 500 along which went up by about 14% this year.

The news agency Reuters quoted strategists at BofA Global Research who said that while the bearish positioning was helping the investors in the first half of 2023, that’s “not the case” in the second half. The allocations in cash dropped to a 21-month low in August at 4.8% according to a survey by banks, forcing them to shift their “cash rule” indicator to “neutral” from “buy”.

Too much pessimism to excessive optimism

“There was plenty of pessimism in the market earlier this year and that shift from pessimism to optimism was fuel for a rally,” said Willie Delwiche, strategist at Hi Mount Research. “We saw it quickly go from too much pessimism to excessive optimism, and now we are starting to see that rollover,” Willie Delwiche added.

Federal Reserve’s annual symposium in Jackson Hole, Wyoming which is scheduled at the end of next week is something investors will watch closely to gauge the mood of the central bank and how much more rate hikes the markets can expect.

With S&P 500 down by over 5%, the optimism which fueled the rally in stocks is being tested now and what remains to be seen is whether the plunge in the market will signal investors to buy more or lighten up on stocks. Moreover, the surge in benchmark US 10-year Treasury is the highest since October 2022, making the stocks less attractive for investors.

Much of the anxiety in the markets is also driven by the worsening property crisis in China and Quincy Krosby, chief global strategist at LPL Financial expects the stocks to remain volatile until the third quarter results come in October. With market stabilization, investors are expected to move to stocks by the end of the year.