Update on Bonds: May 24, 2016

You might be one of those investors who cares nothing about bonds.  With the 10-yr failing to even keep pace with inflation, why bother?  Because, after decoupling in 2014 and part of 2015, stocks and bond yields have mostly moved in tandem for the past year.  Ignore bond yields at your own peril.

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In our January 13 update, I noted that TNX was nearing potentially important support.

Note the white dot at 20.21.  This is not only a key Fib level (.618), but the bottom of a TL off the Jan 30 lows.  As support goes, it’s of average strength.  But, it likely lines up with our 1882-1887 SPX target.  So, I’m giving it the benefit of the doubt.2016-01-13 TNX 5 0845If the trend line breaks, then the next major support isn’t until 1.90 or so– the Aug and Sep lows — which would probably mean SPX 1882-1887 didn’t hold either.

TNX reached 20.21 two days later, bounced for a few days, then broke down below that white channel bottom. Needless to say, SPX 1882-1887 didn’t hold either.

SPX plunged 138 points over the next two days (the thin, purple line.)  Only when TNX bounced back above the channel bottom did SPX recover at all.2016-05-23 TNX 5 1100TNX eventually found support, but it’s been unbelievably wishy-washy about holding that support.  If I didn’t know any better, I’d say TPTB are propping it up.

But, that would mean press conferences, interviews, sound bites wherein Fed presidents talk up the probability of an imminent rate hike, even when it seems contrary to an unending stream of weak economic data.  Come to think of it…

The long-term picture is one of the charts that, back in 2013, had me absolutely convinced that SPX was heading lower.

Previous plunges in interest rates had obviously accompanied plunges in stocks.  The logic is straight forward: stock market crashes drive investors into bonds, which bids up the prices and down the yields.  The 2000-2003 and 2007-2009 crashes are the obvious ones.2016-05-23 TNX wkly big 1743But, TNX experienced a number of less dramatic reversals that accompanied smaller corrections: Apr-Jun 2010 (-15.4%), Jul-Oct 2011 (-20.1%) and Mar-Jul 2012 (-9.9%.)

In September 2013, the 10-yr tagged the yellow trend line from June 2007.  But, SPX was still a little shy of our 1823 target.  So, we forgave TNX when it bounced slightly higher to nail the .618 Fib at 30.13.  As it turned out, SPX nailed 1823 at the same time.  It was a beautiful setup for shorting.

Sure enough, TNX plummeted almost 50% — from 30.36 to 16.51.  SPX, on the other hand, went higher.  A lot.  By the time rates were done dropping, SPX had climbed nearly 15%.  Those bears, like me, who hadn’t noticed the growing influence the yen carry trade was exerting on stocks, did not have a good year.2016-05-23 TNX wkly 1743But, all manipulated things must come to an end.  The BOJ stopped devaluing the yen, and the yen carry trade is a mere shadow of its former self.  So, when TNX began another leg down a year ago, stocks followed along just like in the good old days.   Instead of rising 14.8%, SPX fell 14.9%.

The last stretch of the decline occurred when TNX plunged below our 20.21 line in the sand (the yellow arrow.)  As mentioned above, that led to a 138-pt (7%) decline in SPX.  It was followed by a 108-pt bounce when TNX popped back above support.  But, when the bounce failed two days later, SPX plunged 137 points.

Fortunately for bulls, TNX ran into strong support at the .886 retracement of its rally from 13.94 in Jul 2012 to 30.36 in Dec 2013.  It was the same day USDJPY and CL bottomed, so stocks had a lot of help in kicking off a strong rally.

2016-05-24 TNX v SPX 60 2100While SPX rallied strongly for several months, TNX ran out of steam after just one.  It has since put in two lower highs — hardly the sort of behavior one would expect if higher rates are, indeed, right around the corner.

On the other hand, it’s hard to miss the triangle pattern setting up over the past several months.  IMO, it’s not so far off the lows that it qualifies as a legitimate pennant pattern.  But, it obviously represents a coiling of sorts — exactly the sort of pattern one would expect with a rate decision coming up next month.

Stay tuned.





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