We continue to walk a rather precarious path through the mine fields that describe the markets these days. It would be simpler to join with the crowd and draw support lines across from the bottoms for the S&P 500 Index and Nikkei 225 Index back in 2002 and argue that if these levels do not hold- and they might well not- then ever lower prices would be expected. However… it is not in our nature to trend-follow or deal with what we imagine is the obvious; instead we spend most of our time creating overly complicated theses made up of a conglomeration of markets relationships both past and present.
Our most recent thesis has revolved around the observation that U.S. long-term Treasury prices peaked back in December as yields reached a bottom. As mentioned yesterday we view any decline by 10-year yields below 2.0% as an indication of outright deflation so the bounce upwards from just over 2% was, in our view, the markets’ way of saying that the deflation/reflation outcome was still a bit of a coin toss.
If one accepts the premise that bond prices hit a cycle peak in December then the next step is to put it into some form of meaningful context. Whether our methods are meaningful or not is open to debate but, then again, we rarely take the shortest path when travelling from markets point A to B.
Belowwe show what we believe is the ‘opposite’ of today’s situation. In other words the chart comparison of the S&P 500 Index, gold/copper ratio, and U.S. 30-year T-Bonds futures from 1999 into 2001 represents a similar but inverse situation. Instead of ‘too weak’ growth we had ‘too strong’ growth. Instead of a falling stock market we had a rising stock market and instead of a bond market peak we worked through a bond market price bottom in January of 2000.
We have argued that the ratio between gold and copper trends with the bond market but, as the chart shows, this ratio can diverge from time to time. The bond market bottomed in January of 2000 marking the first indication that growth was eventually going to slow. The gold/copper ratio continued to decline into September- past the peak for the Nasdaq reached in late March and very close to the final top for the S&P 500 Index.
The point is that the markets split the trend change signal into two parts. The first part consisted of a directional trend change for the TBond futures while the second part came from a rising trend for the gold/copper ratio. There was a gap of roughly 8 months between the bond market’s bottom which suggested the potential for slowing growth and the gold/copper ratio’s bottom which argued for the reality of slowing growth. Once the gold/copper ratio pivoted upwards the equity markets broke into a 2-year bear market.
Below we show the U.S. 30-year T-Bond futures and the gold/copper ratio.
Our view is that we are now in between the first and second signal described on page 1. The bond market has peaked indicating the potential for stronger growth while the gold/copper ratio has continued to rise arguing that the markets have yet to come to grips with the idea that conditions are set to improve.
Belowwe show once again the yield spread or difference between 10-year and 3-month Treasuries and the S&P 500 Index. The charts have been shifted in terms of time so that, for example, January of 2007 for the yield spread is lined up with roughly March of 2009 for the equity markets.
The point is that the yield spread held negative for close to 9 months in 2006 and 2007 so it may be that the SPX will work through a bottoming process that will run into the late spring of early summer. If we take the chart comparison literally the start of a return back towards 1000 for the SPX could begin as early as May.
Below we feature a comparison between Micron (MU) and the TBond futures. The idea is that, in general, MU tends to trend inversely to the bond market. The techs were weak yesterday following Hewlett- Packard’s report that first quarter sales were below analyst’s estimates.
The point is that a weaker bond market will tend to go with eventual strength in the tech sector although at present the trend seems to be stuck in between initial weakness in bond prices and the confirmation of improving cyclical strength due a few months from now.