As quickly as possible here is today’s premise. The stock market trends with the bond market. The twist is that in times past it traded with the bond market but now that the major financials are acting like cyclicals instead of interest rate-sensitives the stock market moves inversely to the bond market. In other words… a peak for bond prices should go with the bottom for equity prices.
The second part of the premise is that at times of economic extremes- either positive or negative- the bond market sets the trend but the stock market lags in response.
The bond market turned higher in October of 1981. The chart details that we are looking at are as follows. The equity markets responded to bond price strength during October and November of 1981 rising up to the 200-day e.m.a. line. From there the SPX failed lower reaching a final bottom in August which went with the break out to new highs for the TBonds. From there the equity markets followed the bond market higher.
The chart below shows the TBond futures and the S&P 500 Index from November of 1999 through all of 2000. Our argument is that economic growth in 2000 represented a positive extreme comparable to the negative extreme into 1982.
The TBond futures reached bottom in January of 2000 and began to rise. In 1982 stocks trended with the bond market by 2000 the trend had reversed so that a bond market bottom would indicate a stock market top.
Similar to 1982 the equity markets first reaction was appropriate. In other words the stock market began to decline as bond prices moved higher with the SPX chopping down to the 200-day e.m.a. line. From there the stock market returned to its old positive trend in a manner reminiscent of the negative trend through 1982. For roughly 8 or 9 months as bond prices trended higher the stock market continued to push upwards until finally the TBonds made a marginal break to new highs which went with the start of the bear market that ran through into the fourth quarter of 2002.
The chartbelow compares the U.S. 30-year T-Bond futures with the S&P 500 Index from the current time frame.
On today’s first page we attempted to show that trend changes or pivots for the bond market will change the direction of the base trend for the equity markets. In anything close to normal times a falling bond market will go with rising stock prices while a rising bond market will go with falling stock prices. We have argued in the past that in days of old the bank stocks traded as interest rate sensitives while today they are definitely cyclicals. In other words the perception of the value of a major bank (i.e. Citigroup, Bank of America, JPMorgan Chase, Wells Fargo, Morgan Stanley, etc.) is more closely tied to rising asset prices (cyclical strength) than falling interest rates.
In any event the argument was that the start of a falling trend for bond prices should indicate the start of a rising trend for equity prices. Fair enough. The problem is that it wouldn’t be too big a leap to suggest that this is one of ‘those times’ when economic activity has moved to an extreme. This is one of ‘those times’, similar to 1982 and 2000, when it wouldn’t be too big of a surprise if the equity markets lagged in response.
We attempted to show on page 1 that the initial reaction by the stock market in both late 1981 and early 2000 was… correct or appropriate. The stock market rallied for a couple of months in the autumn of 1981 up to the 200-day e.m.a. line and fell for a couple of month in early 2000 down to the 200-day e.m.a. line.
Our view is that the bond market appears to have made a top in December of last year. If the equity markets responded in the usual manner the trend for the SPX would turn positive leading to a rally back towards the 200-day e.m.a. line. In other words… long-term we are equity markets positive, short-term we are definitely equity markets positive, but medium-term… we are likely no better than neutral. The S&P 500 Index could be 950 or higher over the next few weeks, back to 1300- 1500 in a year or two, but also at or near new lows later this autumn.
At bottom we show the U.S. Dollar Index (DXY) futures and the stock prices of two major Japanese banks- Mitsubishi UFJ (MTU) and Mizuho Financial (MFG).
The first point is that the banks are trading like cyclicals and cyclicals have been trading inversely to the U.S. dollar. A rising dollar has been a negative for cyclicals in general and banks in particular.
The second point is that between our equity markets bullish short-term and long-term views the bearish medium-term view rests on the expectation that the dollar will move to new highs. To tighten this up just a bit the basic argument is that the cross rate between the yen and euro will move to new highs which will then lead to the dollar to new highs.
To put this all together the idea is that as the dollar remains flat to weaker the equity markets are going to rally as the SPX pushes up towards the 200-day e.m.a line. The markets will trade as if Chinese growth is kicking back to life which will go with stronger copper prices and a rising on ocean shipping rates (next page). If, however, the markets are going to lag in response as they did in 1982 and 2000 then the yen will strengthen, the dollar will strengthen, pressure will return to cyclical asset price, and the SPX will move back towards the lows into the late summer or autumn.