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Two Signs of Stock Market Strength, Courtesy of the Bond Market

Falling interest rate volatility in Treasuries could herald a stock market rally.

There are few things that make investors happier than having clarity about where the markets are today and where they’re likely headed. And thanks to some recent bond market trends, investors may have reason to feel pretty happy.

Here’s why: In what is potentially a very big deal, the daily volatility of the 2-year U.S. Treasury note’s yield has plummeted by 9 basis points—from a high of 15 basis points during the banking crisis earlier this year to just under 6 basis points today, as seen in the chart.

Source: Bloomberg, calculations by Horizon Investments, 60-day realized volatility. As of 09/19/23

As we’ve pointed out, falling interest rate volatility can set the stage for risk assets such as equities to rally because lower levels of rate volatility can give investors greater confidence in stock valuations. The recent slide over the past few months means the 2-year Treasury’s volatility level has fallen back to where it was in March 2022 (when the Fed began its aggressive campaign of inflation-fighting interest rate hikes) and is now much closer to its long-term average of 5.5 basis points per day.*

Another encouraging bond market sign: The MOVE index—which essentially measures expected future rate volatility among Treasuries—recently dipped below 100 (which implies a move of approximately 6 basis points per day) for the first time since February and is inching closer to its historical average of 89

None of this means a stock market rally is a sure thing, of course, and other factors (such as oil prices continuing to rise) could put a damper on equity prices. But if realized and expected bond market volatility stay on their current paths lower, stock investors may finish strong in the final months of 2023.

* measured from January 1990

Disclosures

This commentary is written by Horizon Investments’ asset management team.

Past performance is not indicative of future results.

Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security. This report does not attempt to examine all the facts and circumstances that may be relevant to any company, industry, or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Horizon Investments, LLC (“Horizon”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice, or recommendation in this document, clients should consider whether the security in question is suitable for their particular circumstances and, if necessary, seek professional advice. Investors may realize losses on any investments.

The MOVE index, or Merrill Lynch Option Volatility Estimate Index, is a crucial gauge of interest rate volatility in the U.S. Treasury market. Reference to an index does not imply that any account will achieve returns, volatility, or other results similar to that index. An index’s composition may not reflect how a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change. Individuals cannot invest directly in any index. Indices are unmanaged and do not have fees or expense charges, which would lower returns.

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