Rare diagnosis: only 4 times in 40 years

In this article, we look at a market pattern that has only happened four times in the past 40 years and has preceded stock market rallies each time.

Our favorite way to measure inventory the market valuation is the net yield of the SPX (SPX dividend yield minus the 6-month Treasury yield); the higher the net return, the cheaper the stock relative to risk-free treasuries.

Normally, when the 6-month Treasury yield increasethe stock market as measured by the SPX too increasewhile the SPX dividend yield decreases (blue arrows on the graph below). (Note: the net yield always decreases, making stocks more expensive relative to risk-free T stocks).

In the last 40 years, we have found only four cases — 1984, 1987, 1994, 2022 — where the opposite happened; the 6-month yield rose, but the SPX dividend yield increase, while the SPX decreases (black arrows on the graph below).

The following charts take a closer look at each of these periods, starting with the current situation:

Note that the three previous models — 1994, 1987 and 1984 — all lasted less than a year, and that the SPX rallied after the pattern ended. The current version of this pattern is about six months old and should last for several more months before the 6-month Treasury yield stabilizes and the SPX rallies. Investors are advised to have cash on hand when the SPX rally resumes (likely Q4).

We believe the battered tech sector will experience the strongest rebound. Some ETFs to consider buying as we move towards the end of the pattern over the next 2-3 months are: ARKK, AIQ and QCLN.

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