The back half of this week was a lot more interesting than the front half.
AI-related stocks, semiconductors, and technology all came under pressure.
Normally, that would not be something I would necessarily view as constructive.
But something else happened at the same time.
Money started rotating into parts of the market that had been weak throughout September.
That matters.
For now, I still think the broader market looks reasonably healthy.
But I am starting to see some things underneath the surface, particularly in the credit market, that I am watching much more closely.
Breadth Is Finally Improving
One of the main problems with the market from mid-August through the beginning of October was how narrow the rally had become.
Mega-cap technology, semiconductors, and AI-related stocks were doing most of the work.
The S&P 500 kept holding up, but fewer stocks were participating.
That has started to change.
The percentage of stocks trading above their 20-day, 50-day, and 200-day moving averages has improved.
We have not had what I would call a true breadth thrust, but the short-term improvement is noticeable.
The advance-decline line has also continued to hold up fairly well.
Even with the weakness in the major indexes toward the end of the week, the cumulative advance-decline line was still moving higher.
The equal-weight S&P 500 has also started to bounce relative to the regular cap-weighted S&P.
To me, that is constructive.
If money is simply rotating from one part of the stock market into another, that is very different from money leaving the market altogether.
The AI Trade Is Still the Area to Watch
The weak spot remains the AI trade.
The Nasdaq had a rough week.
Semiconductors had a rough week.
South Korean stocks remained weak.
Nvidia made a new high and then quickly reversed.
That does not automatically mean the whole trade is over.
Most of the major moving averages are still pointing higher, and the Nasdaq is still in a longer-term uptrend.
But I do think the recent failed breakout deserves attention.
Failed breakouts can matter.
If mega-cap technology and semiconductors reassert themselves quickly, then this may end up being nothing more than another short-term shakeout.
If they do not, and those prior breakout levels begin turning into resistance, then I think the downside risk becomes more meaningful.
The 10-Year Treasury Came Close to My Target
The other major story continues to be the bond market.
For the last several months, I have been watching a measured-move target on the 10-year Treasury yield near 5.4%.
We got pretty close.
That does not mean yields have to reverse immediately.
But after a move like the one we have had, I would not be surprised to see some backing and filling.
The 5% area is particularly important to me.
That was a major breakout level.
If the 10-year Treasury yield moves back below 5% and stays there, that could begin looking like a failed breakout.
If that happens, we could see a more meaningful decline in yields.
My longer-term view has not really changed.
I still think the broader trend in yields is higher.
But markets do not move in straight lines.
A countertrend decline would not surprise me.
CTAs Are Heavily Short Bonds
One thing that makes the setup more interesting is positioning.
A lot of commodity trading advisors and futures-based funds are currently heavily short Treasuries.
That includes the two-year, five-year, 10-year, and 30-year parts of the curve.
That makes sense.
If your model is trend following and yields are moving higher, you are going to be short bonds.
But crowded trades can get violent when they reverse, even temporarily.
If yields pull back, that could force some of those positions to cover.
That does not mean the longer-term trend has changed.
It may simply create another opportunity later for those strategies to reestablish their shorts.
Credit Is What Has My Attention
The thing I am watching most closely right now is credit spreads.
Credit spreads have widened materially over the last couple of weeks.
Part of that appears to be tied to the financing around the AI and data-center buildout.
Many of the hyperscalers and newer cloud companies are relying heavily on debt to finance enormous amounts of capital spending.
If investors begin demanding significantly more yield to finance those businesses, that tells us something about how the market is viewing the underlying risk.
This is the part of the market I refer to as the plumbing.
When the plumbing starts acting differently, I pay attention.
Bonds Often Give Me the First Signal
One thing I have noticed over many market cycles is that my fixed-income portfolios will often start giving me risk-off signals before my equity models do.
I tend to think about it almost like dominoes.
The first thing I may see is weakness in high-yield credit.
Then bank loans.
Then I may start moving toward investment-grade corporate bonds.
Eventually, if the risk-off move becomes significant enough, I may end up moving toward shorter-term Treasuries.
Some of that has already started happening for me.
Over the last couple of weeks, I have moved toward higher-quality fixed income compared with how I had been positioned for much of the past year.
That does not mean a major market decline is coming.
Credit spreads could tighten again next week and that could be the end of it.
But I do not like what I have seen recently, so I am respecting the signal.
Friday’s Volatility Spike Was Strange
Friday was particularly interesting.
The VIX and short-term volatility futures had a very sharp intraday spike.
What made it unusual was that there was not an obvious piece of news that explained the move.
It was also options expiration, which can create some unusual trading.
My own speculation is that there may have been some type of forced liquidation.
Possibly a hedge fund or other large player that was heavily involved in a long-short AI trade.
I want to be very clear about that.
I have no inside information and no direct knowledge that this occurred.
It is simply my interpretation of the price action.
The speed and timing of the move looked like someone somewhere was under significant pressure and was forced to reposition quickly.
Whether we eventually find out that was the case remains to be seen.
One Hedge I Am Watching
If the AI and high-beta trade continues to unwind, one strategy I am watching is BTAL.
BTAL is a market-neutral anti-beta ETF.
The strategy is effectively long lower-beta stocks and short higher-beta stocks.
That creates a pair trade rather than an outright directional bet against the stock market.
That distinction matters.
If high-beta stocks and the AI trade continue weakening while other parts of the market remain relatively healthy, something like this could potentially make more sense than simply shorting semiconductors or the S&P 500.
I do not view it as a recommendation.
It is simply something I am watching.
One thing I have noticed over different cycles is that strategies like this can occasionally bottom and begin moving higher before the broad stock market rolls over.
That makes it useful as another risk-appetite indicator.
What I’m Watching From Here
Right now, there are a few things I care about.
I want to see whether breadth continues improving.
I want to see whether the Nasdaq and semiconductors can recover from the recent weakness.
I want to see whether the 10-year yield holds above or falls back through 5%.
And probably most importantly, I want to see what credit spreads do.
If credit stabilizes and the AI trade begins recovering, I think this week could end up looking like a healthy rotation.
If credit continues deteriorating and the failed breakout in technology starts turning into something bigger, then I will become more defensive.
For now, though, the S&P remains in an uptrend.
Breadth is improving.
Money is still rotating within the market.
I am not sounding the alarm.
But I am paying closer attention.
Matt Williams, CFP®
JTM Williams Capital Management
The ETFs, indexes, securities, and strategies discussed are for illustrative and educational purposes only and do not constitute a recommendation to buy or sell any security.
