“There are two bubbles: We have a stock market bubble, and we have a bond market bubble” – Alan Greenspan January 31, 2018
This may not come as a surprise, but: I agree with him. Oh I know, every time Alan Greenspan says something related to “irrational exuberance” immediately the comments come that he said it in 1996 and stocks didn’t blow-up until 2000. While that may have been true then it didn’t invalidate his premise nor is the timing relevant to now. Back then people ignored him and went full bubble mode until it popped.
Indeed this one may still go on for a while and 2018 upside risk targets remain despite this week’s first pullback action of 2018. However this week’s corrective move coincided with a sustained technical breakout in the 10 year yield above its 30 year trend line. Markets clearly reacted and not favorably.
Which brings me precisely to the relationship between stocks and bonds. If Alan Greenspan is correct then a chart I have been watching and musing about for a while may be the ultimate bear chart.
I’ve shown this chart before, but let me walk you through the theory of it.
This is a ratio chart of $TNX (10 year yield) vs the $SPX and it reveals a stunning picture:
The correlation is stunning to me from a technical perspective. Why? Because it is so incredibly precise.
Indeed, if Alan Greenspan is right, this chart could have enormous implications for the next few years. This chart could suggests a massive multi year bear market to emerge.
Let me explain why and how.
The ratio bottomed right near the 2008/2009 lows and, as you can see, we’ve seen a continued rise until the middle of 2016. In the years in between a trend line established itself that acted as precise support until the US election. That’s when everything went pear shaped.
Since then the trend line became resistance and the renewed effort to break above it rejected precisely at the trend line again in 2017. Given this history it seems hardly a coincidence, but rather suggests a technical relationship of importance.
Currently we see the ratio dropping hard this week. Why? Because stocks are falling and yields are rising. Which means that for this to move back higher yields must drop and stocks rise. Or at least yields need to stop rising.
But if yields continue to rise and stocks continue to fall the actual pattern of the ratio could be even more alarming:
That’s a massive multi-year heads and shoulders pattern. It’s not confirmed until it breaks its neckline, but consider the possibilities in context of the recent price action and in correlation to stocks and bonds on their own:
Basically what this implies is that the entire rally since the early 2016 lows will turn out to have been a blow-off top. Recall what I said at the outset: The high in the ratio was made in mid 2016. The action since has placed 2 bearish patterns: 1. The trend line break 2. The heads and shoulders pattern.
Now let me clear: I’m not calling for an immediate collapse here, but I’m pointing to a possibly huge structural relationship between bonds and stocks, one that will likely take years to play out. But the signs of trouble are already in this chart. Bottom line: Bulls need yields to drop sooner rather than later or this market party may come to an abrupt end with deep reaching consequences.
There may be hope in the short term as the ratio is about to reach critical support:
But if the ratio breaks below its neckline, then this chart may indeed prove to be the ultimate bear chart.
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Categories: Market Analysis