Trader’s Narrative

It wasn’t that long ago when people were running around pulling their hair out because of a swift sell off in the bond market. As yields spiked in the 10 year and 30 year notes, a lot of attention was invested in trying to explain what this meant.

In early July I showed one simple indicator based on the 10 year Treasury Notes and how it has a very good record of finding market tops - something most indicators are loath to do.

Here is the indicator again, going back three years:

As you can see, this is able to not only find tops, but bottoms as well. Whenever the rate of change of the 10 year T-Notes drops into negative territory, we start to see a high probability of the equity market bottoming. It isn’t perfect, as you can see. It missed the October 2005 bottom (or was early depending on how you want to think about it).

The rational argument is that as bond yields fall, equities become more appealing compared to bonds. And so funds flow from bonds to stocks. Although not simple, it is both logical and fairly consistent. What else can you ask from an indicator?

Last Friday I mentioned that everyone was beginning to fret about the sharp rise in the 10 year bond yield (or fall in bond prices).

I’m not totally convinced that this will mean real trouble for the equity market. We could experience some turbulence but the underlying uptrend is still intact. Atleast from the metrics that I’m following. I really doubt whether this one data point will mean the end of the bull market.

It is true. Historically, when the market was at an all time high and the yield on 10-year Treasury Notes rose sharply over a short time, we have seen at best a sideways to slightly down market going forward (in the short term). But that is far from saying that it has spelled the end of bull runs

In fact, according to this graph, we are most probably seeing the end of the rise in bond yields. The top graph shows the distance of the daily 10 year Treasury Notes from its 50 day moving average. As you can see, whenever it becomes too stretched to the upside, it snaps back. That’s where we are right now.

Of course, it doesn’t have to snap back. The markets are unpredictable. But the only guide we can use are observations from the past. And that is telling us that this recent fall in bond prices is right about over.

And if that does happen, it will breathe new life into the equities market.