This page has been archived and commenting is disabled.
Why the Performance Differential Between Treasury Bonds and the S&P Matters
Courtesy of JW Jones at Options Trading Signals
The wild and manic year of 2011 is starting to wind down as 2012 rapidly approaches. Market participants are waiting to see if Santa shows up with a present or a lump of coal for Wall Street, and performance anxiety is apparent as professional money managers are running out of time to meet their stated benchmark performance.
Hyper-beta stocks such as AAPL and GOOG are likely to be well bid as money managers will chase Beta into year end if prices grind higher. This time of year volume generally dries up and volatility comes out of the marketplace giving the bulls a slight edge in terms of short term price action. While I expect some choppy price action the next two weeks, I believe strongly that we are at a major inflection point.
There are potential warning signs showing up in guidance reductions that seemingly continue to come out. Semiconductors as well as industries which are exposed to emerging markets seem to be indicating that economic conditions may be worsening as a result of the fiscal issues stemming from Europe and a possible slow down in emerging market economies like China.
Just as the end of the year usually leads to light volume drifts higher, it also produces predictions from economists, traders, and famous market prognosticators. No worries, I am not about to produce a list of my predictions as I think it is a futile endeavor. However, I want to point out a divergence in price action in 2011 that continues to defy what most market professionals would have expected in 2011.
The divergence is not some fancy proprietary indicator, but the performance differentials of the S&P 500 Index and 30 Year Treasury bonds. The table below, courtesy of Morningstar illustrates the performance of Treasury bonds year to date as of Friday’s close:
As can be seen above, the Long-Term U.S. Government Bond has returned 23.16% in 2011. Back in January of 2011 had I been informed that as of the close on December 16, 2011 30 Year Treasury Bonds would have returned more than 20% to investors I would have been shocked. Furthermore, I would have expected U.S. equities to have been pounded lower. Treasuries truly have rallied, but the S&P 500 was only trading 3% lower for the year as of the close on December 16th. So what does this divergence mean?
Readers might point out that the Federal Reserve’s monetary policies have had a major impact on Treasury prices and I agree. However, the divergence is remarkable in that either equities are extremely overvalued or Treasuries are overvalued going into 2012. From a long-term technical standpoint, the price action in both underlying assets reveals that we are truly at a major inflection point and the near term price direction will give us clues. The daily chart of the S&P 500 and the weekly chart of the 30-Year Treasury Bond are shown below:
S&P 500 Daily Chart
As can be seen above, a smaller wedge broke down back in November which resulted in a loss of roughly 80 S&P handles in a matter of a few weeks. The price pattern on the daily chart is now in an even larger wedge formation. This type of formation stores significant amounts of “market energy” which will result in a significant move in the price action when a breakdown or a breakout occurs.
30-Year Treasury Bond Weekly Chart
The 30-Year Treasury Bond is on the verge of breaking out to new all time highs as early as this week. The flip side of the bullish argument is that price will fail carving out a double top and sending Treasury prices considerably lower. The S&P 500 is trading in a triangle on the daily chart and the 30 Year Treasury Bond is on the verge of breaking out to the upside. Typically cycles break with the news and I expect a major announcement to take place in coming days / weeks that will enlighten us as to whether the S&P 500 or long term government bonds are expensive.
Clearly Europe will have a major impact on which direction price action ultimately breaks for both Treasury Bonds and the S&P 500. Fourth quarter earnings and final gross domestic product numbers will also be quite telling as to the strength of the marketplace. However, the U.S. Dollar and the Federal Reserve’s forward monetary policy in 2012 will likely seal the fate for both government bonds and equities.
My contention is that the Federal Reserve may find themselves in quite a predicament which may not have a positive long term outcome for the United States regardless of their decision. If Europe starts to fall apart, I will be shocked if the Federal Reserve does not come out with QE III.
The implication of QE III could be quite severe and could cause the Dollar to fall off of a cliff. The Federal Reserve would rather have inflation than deflation, that is without debate. If Europe starts to falter, deflation will become the buzz word and the Federal Reserve will likely act.
If Europe starts to break down and the Federal Reserve does nothing I expect to see a major selloff in risk assets as money will pour into the short term safety and liquidity of U.S. Dollars and Treasuries.
If the Fed initiates QE III, risk assets will rally sharply as gold, silver, oil, and the S&P 500 will benefit. Commodities will enter their final bubble while the S&P 500 eventually would break down violently as interest rates and higher commodity prices hammer the economic cycle.
The daily chart of the U.S. Dollar Index and the Reuters/Jefferies CRB Commodity Index are shown below:
U.S. Dollar Daily Chart
The U.S. Dollar is trading in a consolidation zone near the recent highs. In addition, the U.S. Dollar Index has traced out a rising wedge pattern which could ultimately break in either direction and reinforces that a major inflection point is upon us.
A pullback that tests the lower support level seems likely based on seasonality. These charts are all indicative that something is brewing in the early part of 2012 which may result in major moves in a variety of underlying asset classes.
Reuters/Jefferies Commodity Index Daily Chart
The CRB Index is trading right at key support. Price action could form a double bottom and bounce higher to test the descending resistance line shown above. I would point out the oversold nature of the CRB Index presently. A bounce appears likely, the question is whether price will be able to push through resistance.
A bounce may work off oversold conditions and allow for a major retest of the October 2011 lows. It is not an accident that major underlying asset classes are all coiled up in what is going to be a major move in the early part of 2012. The stage is set, the only question is which outcome and price direction occurs.
I would point out that the Dollar is trading in a tight consolidation zone presently and could break in either direction while the Commodity Index could either be putting in a double bottom (bullish) or possibly could breakdown to new lows. The stage is set for 2012, the question is which direction Mr. Market will choose?
I do not have an opinion at this point in time as to how this situation will finally be resolved. I plan on monitoring the price action while waiting patiently for breakouts in either direction to be confirmed. Europe and the U.S. Dollar are going to be critical in 2012, that is obvious.
We are presently at a major inflection point and frankly whether Santa Claus comes to Wall Street in 2011 is not nearly as important as what happens in the 1st Quarter of 2012 as all of these charts will likely see some form of resolution. Be careful out there.
This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.
Click here to get JW's Free Weekly Analysis
Pic credit: All Posters
»
- ilene's blog
- 7811 reads
- Printer-friendly version
- Send to friend
- advertisements -
Which was why the banksters founded ELX Futures, it goes almost without saying.
Buy Baxter Pharmaceuticals (after the curious weaponizing of H5N1) and gun futures??
The 30 year Weekly seems to me to have technical problems relating to the two sequential weekly gap ups that occured in August 2011. They have never been filled, but they will be filled once the upward push fades. That would significantly break the 2010 August/October highs at about 135. That's going to hurt. Either great news out of Europe or really bad news out of the USA will coincide with this break down, IMO.
The only real buyers of long term Treasuries are Traders and firms who are front running the FED.The ironic thing is that the Fed's policies is negatively affecting some of the banks radically.their cost od f funding is not going any lower(it is already basically at zero),but the return that they get on investentments is going dwon.Within a couple of years virtually every single homeowner who has a mortage and has the ability to refinance will refinace at lower rates..whom does this hurt ,why the banks.
So why is the Fed pursuing such idoitic policies,The Fed has just one mandate now,Facilitating the the finacing of gargantuan amounts of US and indirectly foreign debt.If interest rates ever went up by 3% ,the whole western finncing system will implode.The Fed will try to puts its finger in the dykes fro the near future.eventually though ,the damn will break.
Why would anyone by 30 yr US Bonds at 3%? Buy and Hold?
Inflation is above 3%, and not going to go down in the near term.
Why would anyone buy into a negative real interest rate?
Oh thats right no one is buying, except for Benny and the Bets....
Good analysis, thanks!
I will not sell my physical PMs, but I'm tempted to move some of my PRPFX to cash in case of a pullback (if the "double-bottom" in commodities fails). While I bought it as a kind of hedge position, I have been getting killed with my TBT and it would be nice to see that reverse. I wonder how a large QE3 would affect the long end of the yield curve? We have been surprised by the result of QE2 on the yield curve, so not sure what to do. It seems like there are some big bets being made in favor of QE3 happening by Q1/2 of 2012...
Hell, I'll probably just let it all ride because I haven't made a good bet in a long time.
I bought TBT at $48. Now it's at $18.75. It's been an ongoing nightmare. I can't sell. What to do. What to think.
As the Federal Judge said to me in court "this Court appreciates your honesty in this matter as all anyone does here is lie." My lawyer thought that was the funniest thing ever...and told everyone so. He's no longer a lawyer btw. Nice post..."I appreciate your honesty" because "the only thing men lie more about than sex is the money they make."
OK, next analysis question. udn drops lower again today. is this because of the new liquidity operations of the ecb, or does this once again show indicators of another move down in the market (euro correllation). one supports asset prices, the other isn't good for them
the S & P could break up or down, or it could just muddle out the end, which is what happens when triangles fail to resolve themselves. from here the S & P has no direction. good luck
and why does anyone look at the 30yr bond. with a wave of the hand Greenspan banished it, that's how important it is.
the triangle in the CRB is forming a bearish flag, but it could break out anyway, but they might sell the breakout, anyway. asset prices need to fall to get the economy going, (see Bill Bonner @ Agora on how he is hoping for a depression this year, me too) Bernanke and Obama want to save the stock market, (and your pension fund) and the 1%.
i don't know what a risk asset is really. (anything) but the longer the threat of falling asset prices hangs over our head the longer investors and workers will boycott the economy.
i think Bernanke and company will try to engineer a minor crash so they can justify QE, the PPT and the faux washout. psychologically speaking few investors would be able to resist buying the next dip, after seeing how much the fed committed after 2009 and put a double on. AAPL $1000, just saying that's what Cramer will be screaming, and a lot of people will be buying, and i think they've got the bears by the short hairs once they drop the market another 10%.
but the bears are smart and they'll play the game and the rally will be the tell, from DOW9500 or so when they run out of steam at 11K, it could get ugly again, and Obama will be diselected next fall, who is doesn't matter.
ABT (which stands for Anything But Treasuries) is a risk asset.
Incorporated dick sucking is up, and only up.
Socialist money planning and wealth "distribution" is batting 1.000 as the future is gutted and sold off in the name of "hope."
Bullshit -n- Obama 2012
J W Jones writes above:
« the Long-Term U.S. Government Bond has returned 23.16% in 2011 ... we are truly at a major inflection point ... »
Jim Sinclair has been saying forever that the ultimate top in the US long bond, will be one of the truly colossal turning points. We are perhaps not there yet but perhaps not far away, as Sinclair has indicated.
Just like when the US long bond paid 15.25% interest in the early 1980s - the deal of the century, which few could see at the time ... the top on the long bond may well be a sudden surprise moment in 2012. A thirty-year bull run maybe is enough.
And after that, it may not be too long for things to get to that point Marc Faber suggests, when many derivatives are written off as zero value given the collapsing state of the counterparties.
thanks for article been looking at treasuries and s and p saying what the heck. will send to myself and another. Honestly I think there should be more about this divergance. it makes me crazy the tlt is at the height of the financial crisis, but the s and p remains so high. I have never seen anything like this, and to me it says something very fishy is going on in the market. (manipulation?). I don't know. but I do know it means something is wrong/ rotten in denmark.
"...participants are waiting to see if Santa shows up with a present or a lump of coal for Wall Street.."
a pair of handcuffs would be more 'fitting' ...and more on everyones WS Wish List
let everyone hope Santa can get those ball and chains down Blankfein, Dimon and Corzines chimneys and fit them into their Christmas stockings
Remember, there is only a one character difference, and placement of that one character between:
SANTA (S A N T A)
And
SATAN
(This sure sounds Chrismassy to me??)
All of Wall Street is short treasuries. When they say "Phuck the Government" they mean it. I only know one guy who came out publicly to announce he was long Treasuries...Bill Gross. And even he... "swerved."