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Correlating the S&P

Submitted by Bruce Krasting on 06/17/2010 19:35 -0400

I love correlation trades. They are like women. There is always logic to
them. They are seductive. But you can never really trust them
completely. When you finally fall in love with them they turn on you.
Here’s an example a friend sent to me. This one matched up tight for a
while. Now it is straying.

Consider the correlation between movements in the ten-year and the S%P
during the May 1 – June 8 period. It comes to a .96 R squared. Very
tight indeed.

From June 9 through today’s close the correlation has fallen apart. It
may have been just a short romance. Memorable, but not lasting. Or it
may come back and the good times can continue. Time will tell. One or
the other of the legs in this correlation is “wrong”.

The current level of the ten-year of 3.19% translates into an S%P of
1050. To get back into the tight correlation it would mean a 58-point
drop in the S&P, a tad over 5%.

In order to justify the current level of 1108 on S&P the ten-year
would have to back up in yield all the way to 3.35%.

I think the bond market is looking as if it smells deflation. That stink
is rising. There are plenty of domestic economic numbers that point in
that direction. There is no growth story outside of our border either.
The risk in this trade is that the 10-year moves toward 3%. That would
put the S%P down around 10%.

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Sat, 06/26/2010 - 05:22 | 435058 mbtshoe

Fri, 06/18/2010 - 03:39 | 420894 Young

Okokok hold your horses Bruce! Women are logical? Hahahahahahahahahahahahahahahahaahahahahahahahaahah, *breather*, hahahahahahahaahahahaha

Woman are as logical as the S&P was yesterday. Logic and rationality are not two traits one describes women by...

Fri, 06/18/2010 - 03:43 | 420855 Escapeclaws

Bruce, your first paragraph is the sage voice of experience. As Catullus said, "A woman's words are written on water." How that relates to markets, who knows.

I notice that the euro appears to be stabilizing around 1.22$. At the same time, the euro price of gold has dropped to around 1006. From the chart of the eurusd and gold in euros, the inverse correlation between gold in the euro appears to be holding exactly as has been the case since January. The euro has risen about 3.4% off its low and gold in euros has declined by approximately the same amount.

Thu, 06/17/2010 - 23:50 | 420774 Luke 21

Deflation is back and the S&P appears a little slow on the uptake.

Thu, 06/17/2010 - 23:09 | 420736 celticgold

very good , but didnt know C.D. was embedded in the Economist!!

Thu, 06/17/2010 - 23:10 | 420709 Privatus

More like Diabolus ex machina. Ironically, the vuvuzela-like drone of lifelong statists that the market has failed has a certain truth to it. These Trichets and Bermonkeys and wannabermonkeys should know because they are the ones who killed it. Why is market manipulation A-OK when the state (and its favorites) do it but a criminal act when done by everyone else? Oh yeah, the king can do no wrong. Riiiight. History and current events show that the sovereign, in fact, is signally ready, willing and able to do the most wrong. The genius of the US Constitution was to put the king in a cage. Clearly those days are long gone. And we are being schooled in political economy the econocide way.

Thu, 06/17/2010 - 20:50 | 420571 berated

It makes perfect sense if you include <Deus ex machina>

As Buttonwood points out (and most of us believe): lots of intervention going on....

Thu, 06/17/2010 - 20:49 | 420570 LePetomane

Beastie Boys - Something's Got To Give

http://www.youtube.com/watch?v=XaHEVjIBdrM

Thu, 06/17/2010 - 20:28 | 420553 DoctoRx

But Bruce: you just aren't feeling the love! If the 10 year drops in yield, then the P/E should go up and investors should accept lower dividend yields. And if the 10 year yield rises, it's because of nominal growth, so stock prices should rise. So whichever way you look at it, the only way stock prices shouldn't rise is if the 10 year stays just where it is! Don't you get it? Buy, baby, buy . . .

Thu, 06/17/2010 - 20:03 | 420517 Tyler Durden