We are in a bit of pickle these days. On the one hand we have suggested on many occasions that one should never argue with the bond market. When it begins to trend in a manner that seems to make no sense… the idea is to accept the message and trade accordingly. On the other hand… we keep arguing with the bond market.
Typically when long-term Treasury yields begin to trend lower in the face of a strong cyclical trend it means that growth is slowing rapidly even if takes the rest of the markets a few quarters to figure things out. When yields start to drive higher, on the other hand, the bond market is ‘saying’ that growth is improving. Such was the case in December of 2008 months ahead of March 2009 equity market lows.
In any event… for good or for bad… we continue to argue with the bond market.
Below are comparisons between 10-year U.S. Treasury yields and the sum of the Canadian and Australian (CAD plus AUD) dollar futures. The CAD and AUD tend to trend with Asian cyclical growth and commodity so they are usually in lock-step with Treasury yields.
The next chart is from April of 2008 into January of 2009 so we are focusing on the cyclical melt down that took place through the second half of 2008.
The chart suggests that when the commodity currencies are declining and yields are stubbornly holding… the trend created by the commodity currencies has the potential to be ‘right’. In other words as the sum of the CAD and AUD collapsed between July and November we can see that 10-year yields held near the highs. During the second half of 2008 the forex markets were ‘right’ as the bond market fought the trend.
Lastly we show the same comparison from the current time frame.
The problem that we have is that the commodity currencies keep pushing higher even as yields grind lower. This creates a divergence of sorts as the forex markets call for stronger cyclical growth even as the bond market informs us that growth is failing. In the past we have usually accepted that the bond market is ‘right’ but given the action through the latter half of 2008 we feel a bit more inclined to take the side of the forex markets. The end result is that against our own advice we find that we are arguing with the bond market… and it makes us quite uncomfortable to be doing so.
Equity/Bond Markets
Below is a comparison between Carnival (CCL) and Alaska Airlines (ALK).
Crude oil futures prices went on a rampage between the start of 2007 and mid-2008. The chart of ALK shows that the stock broke down out of a rising trading channel through this time period before swinging back up ‘on trend’ with a vengeance in early 2009.
One of our favorite topics revolves around prices coming ‘back on trend’ because it usually involves crashes or relentless rises depending on the direction of the trend itself. Our thought today is that if ALK- an energy ‘user’- is working so hard to return to a trend that began back in 2002 then perhaps it makes sense for us to hold a positive view on the autos and airlines sector. We have no idea whether CCL will join the party but a move above 45 would certainly be encouraging.
Below we show an upside down view of the sum of 3-month and 10-year Treasury yields from 2008 along with the SPX from 2010. The argument once again is that the bond market leads cyclical asset prices by about two years. If we take this literally then the correction for the SPX through the second quarter of this year lines up with the negative trend for bond prices in the spring of 2008. The point? We still think that there is a window extending through the final half of this year that supports rising stock prices.
And finally we have a comparison between the Chicago Housing Index futures (home prices in Chicago) and the Bank Index (BKX). Our view is that the banks should lead real estate prices and not the other way around. A push back above 60 by the BKX would help support the notion that U.S. real estate prices have made a bottom and are slowly starting to improve. We are not big advocates of a Japan-style period of deflation but a positive trend- even for the final half of this year- will require an upside swing in bank share prices.
