by Kevin Klombies, Senior Analyst

Wednesday, August 27, 2008

Chart Presentation: Bond MarketComparisons

As we await Hurricane Gustav’s arrival in the Gulf of Mexico some time early next week we might has well return to a number of macro chart-based observations and arguments.

We start off with a comparison from 1981- 82. The chart below compares the S&P 500 Index (SPX), 3-month eurodollar futures, and the U.S. 30-year T-Bond futures.

The SPX staged a rather nasty bear market through into the late summer of 1982. Our purpose today is to show how bond price strength helped to swing the equity market’s trend from negative to positive.

The idea is that bond prices tend to rise during periods of cyclical weakness and since the equity markets are often driven by cyclical strength we tend to find rising bond markets going with declining stock markets. However, since both bondsand stocks are financial assets rising bond prices are always a positive even though the reason bond prices are rising is typically a negative.

We generally view the bond market as a sort of ‘floor’ under the equity market. When the economy goes into a slump corporate earnings and stock priceswill decline until the bond market has risen far enough to serve as support for the equity markets. In other words rising bond prices can be viewed as a negative in that they represent cyclical weakness but if bond prices rise far enough they eventually turn into a positive.

The bottom for the SPX in 1982 coincided with both a return to rising 3-month eurodollar futures (as U.S. short-term interest ratesbegan to tumble) and a ‘trend break’ by the TBond futures. After a series of ‘lower highs’ from 1981 into August of 1982 the TBonds finally managed to break to the upside.

Below we show the SPX along with 2-year T-Note futures from 2001- 2002. The first bottom of significance for the SPX was reached in July of 2002 (to be followed by a test of the lows a few months later in October) as the U.S. 2-year T-Notes pushed to new highs. Similar to 1982 the equity markets remained weak as bond prices moved higher and then began to rally once bond prices had broken through to new highs. We will continue with this argument on the next page.