My current discussions on the Market Misbehavior podcast have typically included some feedback on the rate of interest setting, significantly the form of the yield curve. We have had an inverted yield curve since late 2022, and so the yield curve taking up a extra regular form might imply an enormous tailwind to sure sectors and teams. 

When the Yield Curve is No Longer Inverted

Right here we’re exhibiting the Ten 12 months Treasury Yield, together with two methods to point out the form of the yield curve by evaluating completely different durations. The primary panel beneath the value compares the 3-month yield to the 10-year yield, and the underside panel exhibits the 2-year yield versus the 10-year yield.

Again in 2022, each of those spreads went beneath the zero line, indicating that the yield curve was inverted as a result of long-term yields have been now decrease than short-term yields. Because of the Fed elevating short-term rates of interest to attempt to deliver inflation in test after the COVID pandemic, together with a common downtrend in bond costs, this inverted form to the curve raised fears amongst traders for a recession.

With inflationary pressures pretty subsiding into late 2024, the Fed has now begun decreasing short-term charges, which can more than likely trigger the yield curve to regain a traditional form.  As we are able to see from the Dynamic Yield Curve software on StockCharts, the yield curve shifting again to a traditional form can typically result in decrease inventory costs within the short-term. Nevertheless, two ETFs come to thoughts that ought to do higher on this new market part.

Regional Banks Get a Main Tailwind

The monetary sector basically skilled a very weak begin to the yr, with financials underperforming progress sectors into the summer time. However regional banks have begun to mount a reasonably robust rally in This autumn, maybe reflecting optimism going into 2025.

The SPDR S&P Regional Banking ETF (KRE) has proven a collection of breakouts in 2024, together with a brand new 52-week excessive in July on robust momentum, in addition to a spot increased in early November. KRE now sits above two upward-sloping shifting averages, and the RSI suggests robust, however not extreme, momentum.

Regional banks basically borrow cash on the quick finish of the curve, then lend these funds out to people on the lengthy finish of the curve to purchase homes and make different massive purchases. A steeper yield curve would indicate a way more hospitable setting for regional banks, which might imply a lot additional upside for KRE.

Small Caps May Thrive Given Sector Weightings

Whereas the S&P 500 and Nasdaq are each closely weighted in progress sectors like expertise and communication providers, the small cap indexes function rather more of a balanced publicity to worth and progress shares. As visitor Tom Bowley identified on our podcast, smaller firms normally must borrow cash, so decrease charges might imply a greater setting for small caps as properly.

Right here, we’re making use of our Market Development Mannequin to the iShares Russell 2000 ETF (IWM). Just like our essential Market Development Mannequin utilizing the S&P 500, we are able to see that small caps have proven bullish alerts on the long-term and medium-term fashions for all of 2024. Whereas the short-term mannequin has turned unfavourable quite a few occasions this yr, the mannequin at present signifies short-term energy.

The important thing with small caps is the relative energy, which measures whether or not the IWM is definitely outperforming the S&P 500. Whereas small caps have been shifting increased within the second half of the yr, they’ve nonetheless been underperforming massive caps. Nevertheless, given this shift in rates of interest, we could possibly be heading into a brand new yr the place small caps symbolize a good alternative to outperform the SPX.

RR#6,

Dave

P.S. Able to improve your funding course of? Take a look at my free behavioral investing course!

David Keller, CMT

President and Chief Strategist

Sierra Alpha Analysis LLC

Disclaimer: This weblog is for academic functions solely and shouldn’t be construed as monetary recommendation. The concepts and methods ought to by no means be used with out first assessing your individual private and monetary scenario, or with out consulting a monetary skilled.

The writer doesn’t have a place in talked about securities on the time of publication. Any opinions expressed herein are solely these of the writer and don’t in any manner symbolize the views or opinions of every other particular person or entity.