Stocks closed unevenly lower yesterday. The S&P and Nasdaq closed only modestly lower (-0.22% each), which came a day after hitting new all-time highs the day before, while the small-cap Russell 2000 and the large, blue-chip Dow were down by -1.31% and -0.66% respectively.

Big-tech and AI related names continue to enjoy solid support. And do not seem to be affected by rising Treasury yields.

But the other indexes, especially the small-cap stocks, are feeling the pinch. As I mentioned yesterday, since small-caps are more interest rate sensitive than their larger counterparts, given they often carry more debt with more floating or near-dated obligations, rising yields do have a greater impact on those smaller companies. So much so that the Russell, which was leading both the S&P and the Nasdaq with a gain of more than 20% just a couple of months ago, is now trailing those two indexes. To be clear, they are all up, but it's the larger-cap, tech-heavy indexes leading the way now. (YTD, the S&P is up 14.0%, the Nasdaq is up 18.5%, and the Russell is up 12.5%.) And more than half of small-caps are off more than -20% from their summer highs. And, short-interest is at record levels.

But as I also said yesterday, that tells me the pullback is nearing its end. Especially as the tightening cycle looks like it could come to a quicker end than expected, even from just a few short weeks ago.

After last week?s softer-than-expected inflation report, and weaker-than-expected employment report (albeit still good enough), the next interest rate hike has been called into question. Within a span of just a couple of weeks, the odds for a rate hike went from nearly 70%, to completely flipping to now 77% that there won't be a hike at the next Fed meeting later this month (10/27-28).

Nonetheless, yields like the 10-year continue to rise. At one point it jumped to as high as 5.36% intraday, before settling at 5.28%.

But with the spread between the Fed Funds Rate (3.88%), and the 10-yr (5.28%) at 140 basis points, it's completely within the historical norm. Because historically, over the past 40 years (1985-2025), the spread between the two has been 100 to 150 bps, with the median at 120 bps. So I contend that the recent rise in yields is simply a normal reversion to the long-run median spread of 120 bps.

In yesterday's FOMC Minutes, there weren't any real surprises. We already knew the vote was unanimous in September to raise, which they did. And they signaled another hike is likely by year's end. (Although, that was before the latest inflation reports and employment report.)

Anyway, back to yields. When yields finally begin to ease, and when the market looks like it's more likely to be in pause-mode vs. tightening, I would expect the small-caps to regain their leadership mojo. (Actually, even before then as the market is forward looking.)

But again, the S&P and Nasdaq, despite yesterday's modest decline, are trading near all-time highs. And they seem unfazed by the rise in yields. (I mean, there is an unprecedented AI boom going on, so there's that.)

And with Q3 earnings season just a couple of weeks away (stocks typically go up during earnings season ? and the EPS growth forecast suggests another stellar earnings season), I'm expecting big things this month and for the rest of the year.

See you tomorrow,