- New Science in old markets -

Bonds extend, No change in our view of equities

There were daily-scale extensions in the five, ten and thirty year US treasuries on Friday. These occurred in the price series:

And also in two of the yield charts (the inverse of price):

All have the usual meaning – the current move will end hereabouts.

The longer-term picture remains bullish for bonds. They have recently broken up from weekly-scale compressions:

and we have written in the last few months on the reasons for our continued bullishness – the increasing sensitivity of the whole market to the massive purchases stemming from QE. The sellers that were easy to persuade have already sold and higher prices are needed to coax the remaining holders to part with their notes and bonds. This remains the case and the uptrend will almost certainly resume after a reaction that starts around now. There is a bond and note turn due today, meaning that we may expect that reaction to take the form of a dip but it is extremely risky to attempt to catch it. Brave traders may try a short here but don’t risk much and take a fairly quick profit. It is doubtful whether bonds will retrace all the way back to the weekly compression, but if they do, it will be a very good chance to re-buy.

This may of course have some impact on equities but it is not clear what that will be. There has been a fairly strong negative relationship between equities and bonds for some time but the causes for this are not simple. The world’s central banks are pumping money into their financial systems through bond buying. This has pushed bonds up well enough but has largely failed in stimulating economic growth. There has been a lot of ‘leakage’ into other asset markets however and equities have been one beneficiary, despite the dire outlook. Each time some further new evidence of the feeble economic background emerges, worry causes equities to dip while bonds surge upward – this then looks like a strongly negative relationship. Later on, the leakage of money from the relentless buying of bonds resumes, some finds its way into equities and they recover from their dip; this seems like a positive relationship but it is less well defined.

Now that bonds may also dip, the relationship may remain negative – that is equities may rally out of habit. Because the bond market is the ‘pump’ that is pushing asset prices upwards, there is also the possibility that there may be a simultaneous slump in all of them. We have seen weekly-scale top extensions in many equity indices, as reported in recent editions, so we are bearish about US and Southern European stocks in the medium-term. This does not prevent a short-term rally of course but we suspect that it wouldn’t carry far, so we are not changing our advice in equities.

There have also been fresh compressions in Europe that have broken downward, which adds a negative note:

There have also been fresh compression signals in Nasdaq-related instruments (despite three days of weakness) that could still break either way. An example:

As usual in tne case of compressions, these can be used to place protective stops on existing positions. A good break of the Nasdaq highs of Wednesday 3rd April would be a signal to abandon US short positions, for now.

RE