Is tax-loss harvesting for bond funds pressuring yields higher? While patience needed, some positive divergences seen in CCC-BB spreads and Bitcoin/SPX.

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We discuss: how tax-loss harvesting is hitting stocks (expected) but also likely bonds where 13 of 15 largest bond mutual funds down YTD, something essentially never seen.  Divergences of small-caps vs quality spread is likely positive as is the divergence of bitcoin vs SPY 0.04% .

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The S&P 500 is down 2% this week, bringing its loss for the month to -3.5%. Besides a few high-profile negative reactions to earnings (GOOG 0.95%  META -1.04% ), to me, few macro events explain the acute weakness — in fact, US 10-yr yields have been relatively more tame than could explain the -2% decline. It is possible that mutual fund tax-loss selling is playing a bigger role in 2023 than we appreciate:

• The majority of mutual funds have an October year-end (Barrons) and this means we tend to see tax-loss harvesting as we move into the end of the month. 2022 saw this on display as selling of stocks with negative YTD returns were further under pressure towards the end of October 2022.
• This year, not only are there equity tax losses to “harvest” but also bond fund losses. 13 of the 15 largest bond mutual funds and 13 of the 15 the largest bond ETFs are down YTD. Within the last 30 years, this is one of the worst years ever. This selling of corporate and gov’t bonds probably added to some pressure on yields (pushing prices down, yields up).
• Could this amplify what is already a tough week? Perhaps. Tax-loss harvesting is taking place for those equities down YTD. And roughly 50% of the S&P 500 is down YTD. The good news is this selling pressure should abate in coming weeks, as we move into November.
• Despite what many see as a “bad earnings” season, those companies “beating” on EPS are actually doing better than in 1Q23 or 2Q23.
  – 1Q23 beating >2%: +0.2% next 3D
  – 2Q23 beating >2%: +0.3% next 3D
  – 3Q23 beating >2%: +0.5% next 3D
• So, earnings reactions are better but there have been some high profile negative reactions. Overall, with 47% of S&P 500 reported, 79% are beating.
• Despite the elevated VIX (>20), the spread between high-yield and speculative grade bonds, or BB vs CCC, has narrowed. The narrowing of the quality spread is actually a positive sign incrementally and generally takes place when economic momentum is improving. This quality spread has generally rallied since mid-2022 after reaching nearly 2-std deviation wides.
• For the past 20 years, a rally in the quality spread has been associated with outperformance of small-cap stocks. This did not happen this year, in part, we believe due to the combination of:
  – higher interest rates –> hit smaller-caps harder (more leverage)
  – lack of inflows into equities –> hurts smaller stocks
  – general negative sentiment –> small-caps are higher beta
• But in the past few days, we are starting to see some signs of small-cap outperformance. Today, for instance, the IWM -0.39%  finished roughly where it opened, while the SPY 0.04%  finished near the close. According to Mark Newton, Head of Technical Strategy, he believes that a bottom of the relative underperformance of small-caps is near.
• Similarly, since mid-September, Bitcoin and equities have diverged as BTC has gone from $25,000 to $35,000 while the S&P 500 has fallen -6% or worse. Why would Bitcoin diverge from equities?
• There are several possible explanations:
  – BTC is a flight to quality –> but why are bonds down?
  – BTC has specific catalysts like ETF –> maybe but that is more Nov/Jan
  – BTC is sniffing out a future easing of monetary policy –> maybe

BOTTOM LINE: While equities are down sharply YTD, some divergences bear watching

I wish I could say that the selling is coming to an end for equities. There has been a lot of technical damage and this along with the few signs of capitulation (per Mark Newton, see his report from Wed evening) tell me that investors need to be patient. But the window for a tax-loss selling to end is the end of October (next week).

Key incoming data October

•  10/2 10am ET September ISM ManufacturingTame
•  10/3 10am ET JOLTS Job Openings AugustHot
•  10/4 10am ET September ISM ServicesTame
•  10/6 8:30am ET September Jobs ReportMixed
•  10/6 9am ET Manheim Used Vehicle Index September FinalTame
• 10/10 11am NY Fed Inflation ExpectationsMixed
•  10/11 8:30am ET September PPIMixed
•  10/11 2pm ET Sep FOMC Meeting MinutesTame
•  10/12 8:30am ET September CPIMixed
•  10/13 10am ET U. Mich. September prelim 1-yr inflationMixed
•  10/16 8:30am ET October Empire Manufacturing SurveyTame
•  10/17 8:30am ET October New York Fed Business Activity SurveyTame
• 10/17 8:30am ET September Retail Sales DataHot
•  10/17 9am ET Manheim October Mid-Month Used Vehicle Value IndexTame
•  10/17 10am ET October NAHB Housing Market IndexTame
• 10/18 8:30am ET September Housing StartsTame
• 10/18 2pm ET Fed releases Beige BookTame
•  10/19 8:30am ET October Philly Fed Business Outlook SurveyTame
• 10/19 10am ET Existing Home SalesTame
• 10/19 12pm ET Fed (including Powell) at Economic Club of New York
•  10/24 9:45am ET S&P Global PMI October PrelimTame
•  10/26 8:30am ET 3Q 2023 GDP AdvanceStrong
•  10/27 8:30am ET September PCE
•  10/27 10am ET Oct F UMich Sentiment and Inflation expectation
•  10/30 10:30am ET Dallas Fed September Manufacturing Activity Survey
•  10/31 9am ET August S&P CoreLogic CS home price
•  10/31 10am ET October Conference Board Consumer Confidence

Key incoming data September

•  9/1 8:30am ET August Jobs ReportTame
•  9/1 10am ET August ISM ManufacturingTame
•  9/6 10am ET August ISM ServicesMixed
•  9/6 2pm ET Fed releases Beige BookTame
•  9/8 9am ET Manheim Used Vehicle Index August FinalTame
•  9/8 2Q23 Fed Flow of Funds ReportTame
•   9/13 8:30am ET August CPIMixed
•  9/14 8:30am ET August PPITame
•  9/15 8:30am ET September Empire Manufacturing SurveyTame
•  9/15 10am ET U. Mich. September prelim 1-yr inflationTame
•  9/18 8:30am ET September New York Fed Business Activity SurveyTame
•  9/18 10am ET September NAHB Housing Market IndexTame
•  9/19 9am ET Manheim September Mid-Month Used Vehicle Value IndexMixed
•  9/20 2pm ET September FOMC rates decisionMarket saw Hawkish
•  9/21 8:30am ET September Philly Fed Business Outlook SurveyMixed
•  9/22 9:45am ET S&P Global PMI September Prelim
•  9/25 10:30am ET Dallas Fed September Manufacturing Activity Survey
•  9/26 9am ET July S&P CoreLogic CS home price
•  9/26 10am ET September Conference Board Consumer Confidence

Key incoming data August

• 8/1 10am ET July ISM ManufacturingTame
• 8/1 10am ET JOLTS Job Openings JunTame
• 8/2 8:15am ADP National Employment ReportHot
• 8/3 10am ET July ISM ServicesTame
• 8/4 8:30am ET July Jobs reportTame
• 8/7 11am ET Manheim Used Vehicle Index July FinalTame
• 8/10 8:30am ET July CPITame
• 8/11 8:30am ET July PPITame
• 8/11 10am ET U. Mich. July prelim 1-yr inflation Tame
• 8/11 Atlanta Fed Wage Tracker JulyTame
• 8/15 8:30am ET Aug Empire Manufacturing SurveyMixed 
• 8/15 10am ET Aug NAHB Housing Market IndexTame
• 8/16 8:30am ET Aug New York Fed Business Activity SurveyNeutral
• 8/16 2pm ET FOMC MinutesMixed 
• 8/17 8:30am ET Aug Philly Fed Business Outlook SurveyPositive
• 8/17 Manheim Aug Mid-Month Used Vehicle Value IndexTame
• 8/23 9:45am ET S&P Global PMI Aug PrelimWeak
• 8/25 10am ET Aug Final U Mich 1-yr inflationMixed
• 8/28 10:30am ET Dallas Fed Aug Manufacturing Activity SurveyTame
• 8/29 9am ET June S&P CoreLogic CS home priceTame
• 8/29 10am ET Aug Conference Board Consumer ConfidenceTame
• 8/29 10 am ET Jul JOLTSTame
• 8/31 8:30am ET July PCETame

Key incoming data July

• 7/3 10am ET June ISM ManufacturingTame
• 7/6 8:15am ADP National Employment Report Hot
• 7/6 10am ET June ISM ServicesTame
• 7/6 10 am ET May JOLTSTame
• 7/7 8:30am ET June Jobs reportMixed
• 7/10 11am ET Manheim Used Vehicle Index June FinalTame
• 7/12 8:30am ET June CPITame
• 7/13 8:30am ET June PPITame
• 7/13 Atlanta Fed Wage Tracker JuneTame
• 7/14 10am ET U. Mich. June prelim 1-yr inflationMixed
• 7/17 8:30am July Empire Manufacturing Survey
• 7/18 8:30am July New York Fed Business Activity Survey
• 7/18 10am July NAHB Housing Market Indexin-line
• 7/18 Manheim July Mid-Month Used Vehicle Value IndexTame
• 7/25 9am ET May S&P CoreLogic CS home priceTame
• 7/25 10am ET July Conference Board Consumer ConfidenceTame
• 7/26 2pm ET July FOMC rates decisionTame
• 7/28 8:30am ET June PCE Tame
• 7/28 8:30am ET 2Q ECI Employment Cost Index Tame
• 7/28 10am ET July Final U Mich 1-yr inflation Tame

Key data from June

• 6/1 10am ET May ISM ManufacturingTame
• 6/2 8:30am ET May Jobs reportTame
• 6/5 10am ET May ISM ServicesTame
• 6/7 Manheim Used Vehicle Value Index MayTame
• 6/9 Atlanta Fed Wage Tracker AprilTame
• 6/13 8:30am ET May CPITame
• 6/14 8:30am ET May PPITame
• 6/14 2pm ET April FOMC rates decisionTame
• 6/16 10am ET U. Mich. May prelim 1-yr inflationTame
• 6/27 9am ET April S&P CoreLogic CS home priceTame
• 6/27 10am ET June Conference Board Consumer ConfidenceTame
• 6/30 8:30am ET May PCETame
• 6/30 10am ET June Final U Mich 1-yr inflationTame

Key data from May

• 5/1 10am ET April ISM Manufacturing (PMIs turn up)Positive inflection
• 5/2 10am ET Mar JOLTSSofter than consensus
• 5/3 10am ET April ISM ServicesTame
• 5/3 2pm Fed May FOMC rates decisionDovish
• 5/5 8:30am ET April Jobs reportTame
• 5/5 Manheim Used Vehicle Value Index AprilTame
• 5/8 2pm ET April 2023 Senior Loan Officer Opinion SurveyBetter than feared
• 5/10 8:30am ET April CPITame
• 5/11 8:30am ET April PPITame
• 5/12 10am ET U. Mich. April prelim 1-yr inflation Tame
• 5/12 Atlanta Fed Wage Tracker April Tame
• 5/24 2pm ET May FOMC minutesDovish
• 5/26 8:30am ET PCE April Tame
• 5/26 10am ET U. Mich. April final 1-yr inflation Tame
• 5/31 10am ET JOLTS April job openings

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