Saturday, March 9, 2013

How Much Do Bonds Lead Equities

Last week, SPX rose all 5 days. It has, in fact, risen the last 6 days in a row. Bonds, which had outperformed SPX through February, were slaughtered, closing at their lows for 2013 on Friday. $TLT closed in its lower zone on the weekly chart and on its lower Bollinger Band on its daily chart. Many pundits think this signals the all-clear for SPX.

Yields rise (bond prices fall) when investors believe the economy is rebounding. 10 year yields rose 200 basis points between 2003 and 2006, during which time SPX rose 80%. On this basis, the fall in $TLT is a plus.

But US 10 year yields are just 2.05%. The UK, whose economy has stagnated in the past two years, has the exact same yield. Putting it in perspective, the bond market is hardly ascribing any growth to the US economy.

Moreover, bond prices have an asymmetrical relationship to SPX: rising bond prices (falling yields) are often a warning for equities, but a drop is not necessarily benign.

See the chart below; the width of the yellow shading is the time between the bond price low (blue line) and equity price high (black line). A wide yellow band means that there was a few weeks lead time between bond prices starting to rise and SPX starting to fall; a narrow band means that there was next to no time lead time. 

In the past three years, sometimes bonds have given a few week lead time warning to SPX; several times there was no lead time warning at all. In 2011, $TLT hit a new low in early February; SPX dropped 7% over the next month.