US stock rebound masks weakening breadth as downside risks outweigh upside

The rebound in US stocks led by semiconductors and megacap technology shares is likely temporary because of weak market breadth, while a sustained advance would require Treasury yields to decline.

Stocks rallied around semiconductor and large technology names, but weakness across the broader market suggests the move may be a short-term technical bounce. A clear decline in Treasury yields would be needed to support a broader, longer-lasting rally.

In an October 19 interview with David Lin, Jim Welsh, founder and author of Macro Tides, characterized the session as a temporary rebound within a downward trend and said downside risk exceeded upside potential.

Welsh noted that the S&P 500 was up about 50 points even as roughly 600 more stocks were declining than advancing, while the equal-weight S&P 500 was also negative. Semiconductors and megacap technology shares lifted the index, but participation across the broader market remained weak.

He said capital had rotated over the past several months between the Magnificent Seven and semiconductor shares on one side and the rest of the market on the other. Broader stocks were left behind when the market leaders rose, while buying shifted elsewhere when those leaders weakened, leaving the S&P 500 within a limited range.

The relative strength index for semiconductor exchange-traded fund SMH fell to around 30 late last week, creating conditions for a short-term bounce, Welsh said. SMH rose from 503 to about 607 before pulling back to 540, then peaked at 639, near the 634 target implied by an equal-sized advance, signaling that its corrective rally had run its course.

Even if the rebound extends slightly, Welsh said SMH could fall below 503 again and potentially decline toward 460. He described the move as an unwinding in a semiconductor sector that had become heavily owned on strong earnings expectations.

Earnings have reinforced the concentration in technology shares. Since 2023, earnings tied to AI have risen 300%, compared with 15% for the rest of the market, while AI-related stocks accounted for 76% of this year’s earnings growth. Welsh said the strength of those results had created a self-reinforcing flow of capital into the sector.

The direction of US Treasury yields is another key variable for equities. Welsh said yields would need to decline sustainably for the broad market to stage a meaningful rally lasting several weeks rather than only a handful of days.

Treasury yields may be nearing a peak, but Welsh said a turning point had not yet been confirmed. After a prolonged decline in bond prices produced widespread pessimism, investors should begin watching for a bottom in prices and a peak in yields, with extreme bullish or bearish sentiment often signaling that markets are approaching an inflection point.

Welsh said an intermarket divergence in which the 10-year yield rises above its recent 5.36% high while the 30-year yield fails to exceed 5.73% could provide a bond-buying signal. For now, however, the corrective pattern in the 10-year yield still points to another possible increase, leading him to hold off on buying bonds immediately.

This article is based on market data and technical analysis and does not constitute investment advice regarding any security.