Saturday, July 2, 2011

This chart has been predicting the stock market for three years

As we’ve been discussing here for the last month, Treasury Bonds and Stocks have been trading inversely to one another for years now. The big question last time we addressed this was whether Bonds would find resistance at this multi-year downtrend line or breakout and cause havoc in the stock market? Here is what it’s looking like today:

This inverse correlation between stocks and bonds has been very consistent. The 12% rally that we just saw in bonds, however, only brought the market down 8% from the peak and just 6.5% from the February highs that kicked off the 2011 bond rally. A question we had last time we discussed this issue was whether bonds were warning us of something bigger for stocks, or whether the relative performance of the Stock Market was a sign of strength. In other words, without a big drawdown in the stock market, was the upcoming stock market rally going to start from a higher point?

These are all questions that we are trying to answer right now. Look at how powerful this stock market rally has been with Treasuries having just three bad days. If $TLT continues to sell-off, this bodes very well for US Equities. Look at how RSI has been rolling over as $TLT fails to breakout to new highs:

This is a chart we want to watch folks. Most of my readers have equities in their portfolios. I manage equities for clients. If we’re not watching Treasury Bonds, I think we’re missing out on some solid information. From a risk management point of view, we clearly want to keep an eye on the recent highs for $TLT. If last week’s highs are taken out and you start to see 98 on $TLT, then stocks are probably in bigger trouble than we think. Meanwhile, we also want to keep an eye on the recent support levels on the S&P500. These two breaks would probably occur within a couple of days of each other and all bullish bets would be off.

This is all positive for stocks, while bearish for Bonds. These levels hold, and we’re going to have a nice little stock market rally in July.

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