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• The stock market is on the verge of undergoing a significant macro shift that could threaten its recent gains in the short term.
• That’s according to a Wednesday note from Fairlead Strategies cofounder Katie Stockton.
• She warned a rise in the US dollar and interest rates could put a lid on further market advances.

The stock market is undergoing a macro shift that could threaten its recent gains, according to a Wednesday note from Fairlead Strategies cofounder Katie Stockton.

Around the same exact time the stock market found its bottom in October, the US dollar was topping out at its highest level since 2002. From there, the US dollar fell 12% while the S&P 500 rallied as much as 20%.

But now the US dollar is showing signs of moving higher, and that could put a lid on further stock market upside and even lead to some downside, according to Stockton. The US dollar index has rallied 2.5% over the past week, while the S&P 500 has declined 2%.

Interest rates are another threat to stocks, as yields for the 10-year US Treasury bond have jumped 20 basis points to 3.65% since the Federal Reserve signaled that a resilient jobs market could lead to further interest rate hikes. Stockton thinks the 10-year yield could jump further to 3.87%, a resistance level that if broken would give way to further upside at about 4.34%. 

A higher dollar, combined with rising interest rates represents “a macro shift” from the trends that were in place in recent months and supportive of stocks, according to the note. And that shift could lead to a downturn in the stock market.

“Our indicators support several weeks of upside follow-through [in the US dollar and interest rates], which is likely to impact the extremely bullish sentiment that characterizes the equity market,” Stockton said.

The technical analyst pointed to yesterday’s “Extreme Greed” reading seen in CNN’s Fear & Greed Index as evidence that investor sentiment is overly bullish and due for a shakeout.

“The over-bought reading in the Fear & Greed Index puts us on guard for a loss of short-term momentum,” Stockton explained.

From a fundamental perspective, higher interest rates and a higher US dollar could have a negative impact on corporate profits. That’s because high rates can lead to reduced consumption for big-ticket items that often require a loan, like a car or a house. And a higher US dollar is a negative for companies that sell goods overseas as they are forced to convert weaker foreign currencies into a strong US dollar, resulting in fewer dollars being gained.

A sector rotation could be afoot in the near-term, with Stockton pointing out that defensive sectors like consumer staples, healthcare, and utilities could see demand from investors at the expense of mega-cap technology stocks.

Year-to-date, mega-cap tech giants like Amazon, Microsoft, and Alphabet are up 20%, 13%, and 13% year-to-date, respectively.

But some of those gains are already deteriorating, with Alphabet plunging 9% and erasing more than $120 billion in market value on Wednesday after President Joe Biden took aim at big tech in his State of the Union address on Tuesday, and as investor concerns grow about its ability to compete against ChatGPT. 

If the weakness in mega-cap stocks continues, Stockton’s forecast for further choppiness in the near-term could prove correct.