The one thing that we have to keep reminding ourselves of on a regular basis is that the markets lead the news. In other words a dismal stock market forecasts a dismal economy and not the other way around.
We are going to take yet another run at our ‘bonds lead the stock market’ argument today.Below are two comparative charts of the S&P 500 Index (SPX) and U.S. 30-year T-Bond futures. The top chart is from 1981 through 1983 while the lower chart runs from the end of the third quarter in 1999 through the first quarter of 2002.
The argument is that major trend changes for long-term Treasury prices mark major trend changes for the equities markets. If the economy is not too hot or too cold the relationship tends to work immediately but on the rare occasions when economic activity is at an extreme- as was the case into 1982 and 2000- the stock market will lag in response.
Once again… the U.S. bond market bottomed in the autumn of 1981 which in terms of our thesis marked the start of a rising trend for the S&P 500 Index. The SPX resolved higher for a few months before slumping lower through into August of 1982. From there the SPX drove back ‘on trend’ through into mid-1983.
The bond market bottomed at the start of 2000 which, we will argue, marked the end of a rising trend for the equity market and the start of a bear market. Similar to late 1981 the SPX spent a few months chopping back towards the 200-day e.m.a. line before pushing higher into the late summer. From there the SPX moved through a series of break downs on the way to reaching ‘trend’ post-September 11th.
We have done this argument on a number of occasions recently but the one extra bit of information that we wished to convey today is the length or amount of time it took the SPX to return to the ‘trend’ established by the initial reaction to the bond market’s directional change. In other words when the bond market turned higher in 1981 and 2000 the stock market created a trend line through a series of choppy reactions that would eventually be returned to. From the pivot in the bond market in 1981 to the return to ‘trend’ in 1983 21 months elapsed. From the pivot in the bond market at the start of 2000 until the return to ‘trend’ in 2001 exactly 21 months passed by. The point is that IF the bond market made a trend change from higher to lower at the end of 2008 THEN the SPX should be working through the process of setting a trend.
Belowwe show the SPX along with the TBond futures from the current time period.
The argument is that the bond market reached a peak at the end of last year which, in turn, created a rising trend for the equity markets. The initial response by the SPX to bond market weakness was positive so we have added a rising trend line on the chart.
Our thought is that if we had to draw a rough road map of our expectations of the SPX through the next couple of years it would look something like the dashed line on the chart. The SPX still has the potential to resolve up towards 1000 in the short run (i.e. into March), decline back to the lows or even to new lows into the summer, and then push all the way back to the highs near 1550 by the autumn of 2010. In other words IF- and this is still a big IF- the bond market peaked at the end of 2008 AND the markets take the same length of time coming back on ‘trend’ as they did in both 1981- 83 and 2000- 2001 THEN a recovery that begins towards the second half of this year will run all the way through into the third quarter of 2010.
Quickly… below we show the S&P 500 Index and the ratio between the Morgan Stanley Consumer Index and Cyclical Index. The Consumer/Cyclical ratio tends to reverse or break out at key points for the SPX. If this is going to be a bottom for the SPX then the ratio has to do one of two things- either break to new highs indicating that the trend for the next few years will be dominated by the consumer sectors or reverse direction as the cyclical sectors swing back to life.
Quickly as well… the chart below compares gold futures with the spread between the U.S. Dollar Index (DXY) and TBond futures. A rising trend for gold prices goes with a falling spread line. In other words strong bond prices and a falling dollar leads to rising gold prices.
Our thesis is that bond prices have now turned lower which removes one of the key ‘drivers’ for better gold prices. If the dollar were continue to rise as the TBonds declined then this would describe a base trend that would be very negative for gold prices and very positive for the non-commodity cyclical sectors.