Yesterday, stocks climbed sharply higher as the Federal Reserve hinted at interest rate cuts in 2024. Today, leading U.S. market indexes advanced again, with the Dow Jones Industrial Average (INDU) recording new all-time highs for the second time this year.
As the Fed pivots toward lowering rates next year, the 10-year Treasury yields (TNX) fell 100 bps in the past month in anticipation of rate cuts. On the equities side, lower interest rates have helped power stocks higher, as evidenced by INDU trading to new all-time highs.
If the interest rates continue to trend lower, possibly to retest 3.25% or the 2023 lows, does this imply higher equity prices into year-end and early 2024? Will other U.S. indexes also record new all-time highs?
Investors, specifically long-term passive investors, tend to buy exchange-traded funds to replicate the performances of the SPX, INDU, NDX, and others.
For instance, the SPDR S&P 500 ETF Trust (SPY) is the ETF that tracks the performance of the S&P 500 Index. SPY was introduced in 1993 and is one of the oldest and largest ETFs, with a current market-cap weight of $445.58 billion. The SPY is approximately 1/10 of the price of the SPX Index. If SPX is trading at 4,600, the SPY should trade around 460. Typically, there is a high degree of correlation between the two instruments.
Although SPY or SPX typically trade the same, sometimes the share price of each can vary, providing astute traders short-term opportunities to take advantage of the discrepancies in pricing.
Discrepancies have developed between INDU and DIA, SPX and SPY, NDX and QQQ.
Historically, most discrepancies between the indexes and the ETFs will often return to their close correlations as sophisticated traders, including risk arbs, program trading, and computerized electronic trading desks, close the spread differences between the two markets.
INDU broke out above 36,952.65 (1/5/22) yesterday at 37,090.24 (12/13/23). On the other hand, DIA ETF (373.33) broke out above the 1/5/22 all-time high (356.07) on 11/30/23 and has soared far above its previous record. INDU and DIA broke out to record highs before other popular indexes hinted at leadership roles. However, the wide spread between INDU and DIA also warns that this is not sustainable. Will INDU quickly catch up to DIA, or will DIA begin to slow down its outperformance and realign with INDU?
SPX (4,719.55) is shy of its record high of 4,818.62, established on 1/4/22. The SPY ETF (472.01) eclipsed its all-time high of 467.13 (1/14/22) at yesterday’s close. Does this imply SPX will soon trade to all-time highs?
QQQ ETF (403.39) nears a breakout above the previous 11/22/21 all-time high of 403.43. On the other hand, NDX (16,537.83) is slightly below the 11/22/21 all-time high of 16,764.85. Will NDX catch up to its ETF counterpart?
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