Like the last few poker chips being shoved across the table after a prolonged run of bad luck, the Dow Jones Industrial Average finally surrendered the last of its remaining year-to-date gains on Friday.

The blue-chip index opened the first trading day of 2023 at 33,148 and advanced as high as 35,679 in August. But that hard-fought ground couldn’t be held. It finally slipped below the 33,000 level, descending into negative territory for the year. The Dow has rebounded somewhat since then, but it’s still teetering on the precipice.

The S&P 500 is still clinging to a decent 12% return, but that’s largely driven by a handful of giant tech stocks. Weight all 500 constituents equally, and the return suddenly dives to a negative 1%.

Keep in mind, this all occurred before last weekend’s violence in Israel. So what’s going on here?

The Bigger Bond Picture

It’s no coincidence that stocks are bottoming just as bond yields reach fresh new peaks. The 10-year Treasury, which influences everything from credit card interest to mortgage rates, spiked to 4.80% this week – the highest level in 16 years.

The bond market has been in an uproar since the last Fed meeting. Hawkish commentary from policymakers has left many traders convinced that the short reprieve is over, and yet another hike could be on the table in November (the odds of that happening are only 13.5% as of this writing, though). But it’s not really the terminal Fed Funds stopping point that has investors worried. The difference between 5.50% and 5.75% in the grand scheme isn’t terribly meaningful.

Looking Ahead

The bigger question is how long we stay at this restrictive level. While inflation has cooled to around 4%, it’s still not back within the Fed’s 2% comfort zone. And the Central Bank has made it abundantly clear that more pain may need to be inflicted on the economy to reach that goal.

Terms such as “passive tightening” are being thrown around. But the phrase du jour seems to be “quite some time.” As in, interest rates probably won’t moderate for quite some time. That’s the exact terminology Cleveland Fed President Loretta Mester used. So did Chairman Jerome Powell.

What does that mean exactly? Well, it’s an imprecise way of saying there is no rate relief on the horizon. Few are penciling in a rate cut before the second half of 2024. Those looking to buy a new car or refinance a student loan probably shouldn’t hold their breath.

For now, all eyes are on the labor market. There are 9.6 million job openings, an increase of 700,000 over the past month. All those “help-wanted” signs suggest that the Fed hasn’t yet struck a balance between labor supply and demand – hence the volatile surge in 10-year yields over the past two weeks.

Friday’s blowout jobs report certainly won’t do anything to alter the Fed’s tightening bias. The U.S. economy just added 336,000 jobs in September, nearly double the 170,000 economists expected.

How To Respond

Of course, other macro concerns are weighing on the market, not the least of which is the broad slowdown in consumer discretionary spending, and a fresh outbreak of violence in the Middle East.

Over at High-Yield Investing, I’ve generally been on the defensive since March. Our cash stockpile has risen as we’ve selectively taken profits. I continue to set trailing stops strategically, and I’d encourage you to consider the same.

Also, as I’ve written about before, there is one bright side to higher rates. You can take a couple of simple steps and sweep extra cash in your brokerage account into a stable money market fund (where you can earn between 4% and 5%).

But when appropriate, I will also follow Warren Buffett’s famous creed and be greedy when others are fearful – selectively doubling down on oversold, high-quality dividend payers.

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