Tuesday, September 10, 2013

Observations on Stocks and Bonds

by Pater Tenebrarum

SPX Retakes 50 dma

Yesterday's move in the SPX back above the 50 day moving average bore a very close resemblance to the last occurrence in early July. As the chart below shows, both the price movements prior to the break, MACD and the relative position of the 20 day moving average looked almost exactly similar:

SPXSPX: regaining the 50 day moving average in a similar manner as in early July – click to enlarge.

Different Levels of Bullishness Displayed in Positioning/Sentiment Data

What is different are a number of ancillary data. For instance, there is far more enthusiasm about this move in the option pits than there was last time around, but there is less bullishness detectable in sentiment surveys. This may be partly due to the relative strength in technology shares, which never really corrected much. The options of many big cap tech stocks are quite heavily traded.

equity p-c

The CBOE equity put-call ratio was far lower on Monday's regaining of the 50 dma than on the occasion of the early July move – click to enlarge.

consensus inc

Curiously, there is somewhat less bullishness in sentiment surveys – this is the Consensus Inc. survey, but other surveys show similar tendencies – click to enlarge.

NDXThe NDX diverges by making a new high – its relative strength may explain the fairly sanguine stance of option traders – click to enlarge.

Bond Yields Are Higher This Time

And here is another difference to the situation in early July -  bond yields are higher this time around:

TNX10 year note yield: it still looks to us like it wants to go even higher – click to enlarge.

At the moment, stock market participants are evidently not worried about higher bond yields, since they are seen as a sign of improving economic growth and are not yet deemed high enough to seriously impair stocks on a comparative/competitive basis. However, if yields continue to go higher and especially if they do so quickly, the bond market will become a problem for stocks at current valuations.

Note that although there are sentiment and positioning extremes in bonds and notes (according to surveys and futures positioning), the chart of the t-note yield shown above continues to look bullish (i.e., bearish for bond prices). It is still sporting the 'running correction' look we have previously pointed out, and there may even be a first and second wave in by now, or a series of them (we will know soon whether that is the case). No matter which way one slices it, the chart as such indicates that higher yields are likely in the offing.

One possibility worth considering is that the SPX will make a third run-up in a 'three runs to a top' type formation (an ending diagonal in e-wave terms), and that bond yields will continue to rise while this happens – provided the retaking of the 50 dma holds up and the index is not immediately rejected again similar to late August. There is also still a little time before a potentially troublesome news backdrop begins to unfold, in the form of the FOMC meeting next week, the upcoming debt ceiling debate in the US and the German election – all of which could prove to be short term trigger events.

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