It is the final day of the Canadian long weekend and for as much as we enjoy sitting in the office hammering out the IMRA… we are going to attempt to do this as quickly as possible.
The ongoing argument has been that if the bond market holds below the price peak set at the end of last May then the equity markets should lift as equity valuations expand as an offset to the previous decline in Treasury yields. But… how long might this process run? One answer would be eight more months.
We have included three charts of the S&P 500 Index and the ratio between Johnson and Johnson (JNJ) and the U.S. 30-year T-Bond futures. In 2009 (top right) the SPX rose for 10 months once the JNJ/TBond ratio began to rise. In 2010- 11 the cycle once again ran for 10 months with the SPX topping out once the JNJ/TBond ratio approached .55.
The current trend began at the start of June so if history were to repeat the SPX would grind upwards through the first quarter of 2013 as the share price of JNJ worked back up to around 55% of the price of the TBond.
We are going to stretch a bit with this one. As usual. The inspiration for this came from some work that we did a week or so back when we showed the sequence from 1985- 87 that began with falling oil prices and rising bond prices ending in due course with a stock market ‘crash’.
Below is a chart from 1985- 87 of the TBond futures, crude oil futures, and the ratio between the S&P 500 Index and the TBond futures (equities versus bonds).
The stock market ‘crash’ in 1987 was the end result of a collapse in oil prices from 1985 into 1986 that sent bond prices soaring. By the end of 1986 crude oil futures prices had risen back above the 200-day e.m.a. line which helped initiate a frantic shift back towards more economically sensitive assets. In other words… oil prices plunged and bond prices soared and then as oil prices began to rise money rotated from ‘risk off’ back to ‘risk on’. The stock market went berserk to the upside as bond prices collapsed until the equity/bond ratio peaked and crashed.
Is there even the smallest similarity to the current time frame? Not, we would argue, from the perspective of oil prices but perhaps if we were to use some other cyclical market.
The argument is that similar to 1985- 86 the bond market has driven sharply higher from 2011 into 2012. The offset hasn’t been a 66% decline in crude oil prices but instead weakness in a variety of markets and sectors including everything from Greece to copper, China to dry bulk shipping and the laggard banks.
The 1985- 87 sequence included sharp cyclical weakness and rising bond prices, a period of consolidation or ‘healing’, and then a rapid shift back to cyclical assets in the face of declining bond prices. The current situation has included significant cyclical weakness and a very strong bond market so in due course one could imagine a scenario where the liquidity shoe-horned into the perceived safety of the Treasury market begins to migrate back towards ‘risk’.
Below is a chart of the euro futures, Hong Kong’s Hang Seng Index, and the U.S. 30-year T-Bond futures.
We might have used the Greek stock market or something like the share price of Research in Motion or any of the dry bulk shipping stocks but the euro and Hang Seng should suffice.
The rising trend for the TBond futures has been an offset of the weakness in cyclical growth. One of the facets of this weakness has been the series of crises roiling through the Eurozone which, in turn, has led to a weaker euro against the dollar and Japanese yen.
Concerns with regard to Eurozone growth has weighed on the Asian markets- including the Hang Seng Index. The Hang Seng Index trades almost ‘dead on’ copper prices.
If the pivot point for the trend in 1986 involved crude oil futures rising back above the 200-day e.m.a. line then we can at least argue that the Hang Seng Index is close to ‘the line’. The euro would still have to rise back to or above 1.30. If both move above their moving average lines then we would expect to see some kind of downward pressure on the bond market developing through the final quarter of this year.
