Expect Interest Rates to Keep Falling and Stocks to Soar

The epic rally that ended 2023 wasn't just about market fundamentals...

It didn't happen because of quality earnings or an improving economic outlook. And it certainly wasn't because folks felt more secure about the state of the world.

Instead, stocks soared for a simple reason: Interest rates were falling... and they were falling fast.

The 10-year Treasury yield hit 5% in late October. That made investors nervous. But the yield fell as quickly as it rose. By year-end, it dipped below 4% once again.

We have good reason to expect this fall to continue. As I'll explain today, the 10-year yield could easily fall to 3%. And that would be a clear catalyst for much higher stock prices...

It's not a one-to-one relationship, but interest-rate moves affect stock prices in a big way. That's because higher yields create competition for stocks.

We saw this play out last year when 10-year yields topped 5% for the first time in more than a decade. Folks jumped on the opportunity to earn low-risk returns. Trillions of dollars moved into money-market funds.

But when yields fall, that competition for stocks decreases. Instead, investors chase higher returns in the stock market.

That explains why stocks soared in the last two months of 2023. Yields collapsed... And folks poured money into stocks as a result.

Importantly, this trend is likely to continue. We can see it by looking at the Commitment of Traders ("COT") report on the 10-year Treasury bond...

This report gives us a look at the real bets of futures traders. It's an easy way to see what these folks are doing with their money. It's also a powerful contrarian tool for investors.

When futures traders are all bearish on bond prices, a rally is likely. And remember, bond prices and yields trade in opposite directions. So a negative COT on bonds means everyone is bearish on prices – and no one expects yields to fall.

The COT spent the past few years dropping further and further below zero. And despite the recent fall in yields, that bearish sentiment hasn't fizzled out. Take a look...

The COT for 10-year Treasury bonds hit the lowest level in more than a decade last year. And these folks would need to walk back a ton of bearish bets before we're anywhere close to normal.

You can also see that the only similar situation in the past decade was in 2018. If we look back at what happened then, it's clear that a return to normalcy isn't likely as yields fall even more from here.

Back then, yields peaked at 3.24% and declined to 1.46% by mid-2019. That's a fall of nearly 1.8 percentage points in less than a year. Check it out...

Now, as you can see, yields are falling again. It might be easy to look at the recent drop and assume the move is over. But history shows that yields could fall much further from here.

Sentiment is still incredibly bearish on 10-year bond prices. That means yields can keep falling. They'd need to hit roughly 3.25% just to reach the same overall decline we saw in 2018 and 2019.

The total fall could be much larger, though, for two simple reasons. First, sentiment is more bearish now than it was back then... And second, yields started from a much higher level, making a larger decline easier to achieve.

Put those two together, and the odds of the 10-year Treasury yield falling below 3% this year are higher than anyone believes possible. That move would catch investors off guard... and cause stocks to absolutely soar.

This scenario is more likely to happen than most folks think. And that means we want to bet on a continued stock rally.

Good investing,

Brett Eversole

Further Reading

"Stocks are set to head higher this year because good years tend to follow good years," Brett writes. Last year, the stock market finished up 26%. And according to history, the gains won't end there. Similar setups have led to double-digit returns over the next year... Read more here.

The "Magnificent Seven" tech stocks were the big headliners in 2023. This wasn't surprising, given their outperformance... But they weren't the only reason the market finished strong last year. Two indicators tell us a broad market rally is underway... Learn more here.