We are going to move the chart-based argument that we made on page 5 yesterday up to the front of the class. Keeping in mind that our argument through the first three days of the week was that the U.S. equity markets would stage a rally from March into May we thought we would attempt to explain how this should work.
Belowis a chart from 2000 that compares the S&P 500 Index (SPX) with the yield index for 30-year U.S. Treasuries (TYX).
Long-term Treasury yields peaked in January of 2000 and began to decline reflecting the bond market’s forecast for much slower future growth. The problem was that yields began to decline far in advance of actual bearish news. Since lower interest rates are, all things being equal, a positive for equity prices this helped drive the S&P 500 Index upward from around 1350 to 1550. The peak for the SPX was reached in early April as 30-year yields made a low.
The relationship between interest rates and equities is somewhat strange in that lower interest rates are always a positive for financial asset valuations even as the reason rates are falling- slower growth- is a negative. We will argue quite often that equities rise when yields rise but the issue isn’t yields- because rising yields are a negative. The issue is that yields are rising because growth is expanding and the positive impact of expanding growth tends to swamp the negative impact on valuations from rising yields.
In any event… it is still our conviction that long-term Treasury yields bottomed last December and this means that later this year we will discover that economic growth is surprisingly strong. The problem recently was that the bond market- similar to 2000- made its pivot so far in advance of ‘the news’ that it pushed the equity markets lower. In other words yields were rising because growth later this year would improve but in the ‘here and now’ the rise in long-term interest rates was somewhat akin to trying to swim wearing a full suit of armor.
The chartbelow shows that as yields pushed higher from December into March the SPX declined from around 950 to well under 700. Our view is that equity markets strength this week reflects the fact that yields have stopped rising similar- in reverse- to the way the bottom for yields in April of 2000 marked the top for the stock market.
Equity/Bond Markets
To start the week we argued that if history were to repeat we would expect to see a broad recovery in the equity markets from March into May. Yesterday and today we ‘fine tuned’ the argument by suggesting that it would be driven by lower long-term yields. Keep in mind that it is still our conviction that yields will resolve to the upside for much of the year with 30-year Treasury yields pushing through 5% by the first quarter of 2010 but… for now… yields look lower and, in response, equities look better.
Belowwe show a chart of gold producer Newmont (NEM) and the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX).
The ongoing argument has been that the equity markets will mount a sustainable rally when the XOI/SPX ratio finally breaks to the down side. To the extent that money has been moving towards gold as pressures have intensified on the banking system the idea then spread to include gold and the gold miners.
Below we show the XOI/SPX ratio once again along with the share prices of Wells Fargo (WFC) and Carnival (CCL). The simple point- for the hundredth time- is that the weaker the XOI/SPX ratio the better the trend for the broad equity market.
Below is a chart that we have shown a couple of times in recent days. The idea is that Goldman Sachs (GS) is a true ‘market’ stock while the Volatility Index (VIX) declines when negative pressures abate. In other words the stronger GS is and the weaker the VIX is the better so a rising ratio is bullish while a falling ratio would be bearish.
We marked resistance/break out for the ratio at the highs set in October, January, and February. Yesterday the ratio touched the same level for the 4th time.
