Thursday, March 25, 2010

Higher Yields, Lower Equities?

For the longest while, my mind set has been to expect higher yields accompanied by higher equity prices. After all, wouldn't higher yields be a sign that the economy is expanding and on the track to recovery? Or to put the relationship between bonds and equity prices in another light: if the equity markets would ever sell off, wouldn't bonds catch a bid as there is a flight to safety? But the technicals have me rethinking these relationships. Is it possible that we could have higher yields and lower equities?

Let's start by giving you some background. I have been bullish on Treasury bonds for some time. I was betting with the "smart money" and against the "dumb money", and after much consternation, I felt this was the correct play. I had identified key support levels, and although Treasury bonds could not breakout higher, support was holding. I was becoming increasingly bearish on equities, so I thought that it was only a matter of time before bonds caught a bid. Equities would fall and bonds would move higher at they are seen as a safe haven.

But I don't think it is going to work out that way. I still remain bearish on equities, but it is becoming increasingly difficult to remain bullish on bonds. In fact, the technicals now have me bearish on bonds.

Figure 1 is a weekly chart of the 30 year Treasury Bond Interest Rate (symbol: $TYX.X). Key pivot points are identified with the yellow dots, and these are areas of support and resistance. Negative divergence bars, which tend to act as inflection points as well, are the pink labeled price bars. We note that there is a cluster of 2 negative divergence bars (inside the gray oval). It appears that the 30 year yield will close over 3 key pivots at 46.91 and above the cluster of negative divergence bars. This is very bullish for higher yields, and in all likelihood, this could be strong move higher - think short covering with closes above negative divergence bars -that could see yields on the 30 year Treasury eventually reach 5.282%.

Figure 1. $TYX.X/ weekly

Let's look at this from another perspective. Figure 2 is a weekly chart of the i-Shares Lehman 20 + Year Treasury Bond Fund (symbol: TLT). This is a bond fund that moves opposite to yields. Key pivot points are in yellow; the pink labeled price bars are positive divergence bars. The important area of support is formed by the key pivot point at 89.38 and the low of the positive divergence bar (see price bar with red arrows) at 89.19. A weekly close below these levels, which seems likely, should lead to a much lower TLT. Once again, closes above or below divergence bars tend to lead to accelerated price moves.

Figure 2. TLT/ weekly

For now, TLT has breached support rather convincingly. However, the fake out or reversal needs to be considered. A weekly close back above the high of the positive divergence at 90.65 would be a sign that TLT is going higher (yields lower).

Now let's take a look at the daily chart for TLT. See figure 3. Key pivot points are in red, and today's closing price is below 3 consecutive pivots, and this is bearish. Price has yet to close below the lowest key pivot at 88.64, but this is a couple of cents away.

Figure 3. TLT/ daily

How about the daily chart for Ultra Short Lehman 20 plus Year Fund (symbol: TBT). This is a 2x leverage product that tracks yields or is inverse to TLT. Key pivot points are in red, and a close above 3 key pivots is bullish; TBT is now breaking out and has a price target of $55.

Figure 4. TBT/ daily

Let's address several things before wrapping this up.

Could this be a fakeout? Absolutely. TBT and TLT have been very tricky. Just last week I wrote that TLT was my best looking position - it looked poised to move meaningfully higher. So we have our points where I will be wrong again - if I am wrong again!

Why are yields moving higher? Most would agree that deflation, not inflation, is in our immediate future. How about higher yields and better economic growth? The data doesn't really support it. My belief is that is has to do with debt issuance and supply and demand. I believe Moody's downgrade of Portugal's debt reminded the markets that the coming year is going to filled with a lot of sovereign debt offerings. Who is going to buy that debt? Which debt is going to be the most attractive? Higher yields seems inevitable.

Lastly, does this mean equities will rise? After all, aren't rising yields a sign of economic expansion? In this instance, this is not the case; this is all about supply and demand. Furthermore, extreme bullish sentiment plus yield pressures is a bad combination for equities. See "Danger, Danger Will Robinson".


cowcalf said...

why would not the countries simply buy each others debt to stave off a wreck for awhile? The would print money to buy the other countries debt and visa versa?

Guy M. Lerner said...

I don't know but I would refer you to article in this morning's WSJ on Treasury yields

D-man said...

they can (actually they do it: Japan & China buys USA's; USA's buys its own bonds); it will destroy currencies, but they sure can (and will). this is how these leaders function: they save their ass after creating the whole mess.

"I still remain bearish on equities, but it is becoming increasingly difficult to remain bullish on bonds. In fact, the technicals now have me bearish on bonds. "

Smart money, huh?

Guy M. Lerner said...


I don't see your point? Please explain...

Anonymous said...

I see it this way.Hgher equities ,higher risk equates to positive outlook for the basic economic activity. However ,if that holds true why would one wish to keep hoovering up record amounts of public debt are yields that guarantee a loss of capital ?
So, higher public debt yields to me means bond holders are striking for parity with economic growth. Of course the big question is how far can that go before it sinks economic activity and equities fold by implication.

I'm neither bullish nor bearish on this situation as I think we are in for a game of push pull between the two which almost guarantees a fairly wide ranging market for them in the future. However, how you time that except using technicals I don't know.

D-man said...

Guy, I just want that what we call smart money are not that smart; but strictly to your analysis, you call COT data smart; I commented here the COT doesn't offer an edge as most of the transactions the so called smart do are dark pools; so COT is of no value so to speak.

As a side note I just went through an article of Brian Pretti (I like his analysis) on a sort of simple yet effective indicator for the S&P 500; its basically a nice way to use the 50 DMA. Have a look; you can integrate this with your "trading system" and it might get even more accurate; that will give

- price penetrates the 40 week MA
- we introduce the gold, oil & yields filter

here is our trading system

and here is Pretti's

thanks for letting me know what you find, if it looks interesting to you, of course.

D-man said...

ok, I wanted to say the new system will give

- price penetrates the 40 week MA
- we introduce the gold, oil & yields filter
- S&P percentage difference relative to 50 DMA

Guy M. Lerner said...


I would tend to agree and I believe I have stated before that the COT is very difficult to use; yet when I made the analysis of Treasury Bonds last time, I felt that going against the dumb money and with the smart money (i.e., commercials from the COT) was just one of the reasons of trying to resolve what has become a very difficult issue --that issue being higher yields v. lower yields....this week looks like higher yields will prevail

I have tested the COT data out the wazooo, and it is probably no better than a 4-5 week oscillator in a bull market; in bear markets it is very sketchy

On the trading system: I think what you are asking me is there a system where I combine the gold, crude, yield filter with the 40 week moving average of the SP500? The answer is yes; on the site see if you can find the two articles on developing a trading strategy because that is what I did; I need to do a third article on actually combining the two and the data is rather good on this as it turned in a return almost 2x buy and hold with about 15% draw down (i think); a fourth article would be comparing my work to some other strategy like the 10 month MA model; the model I have developed is actually better because it is less dependent upon a single trade

I will look at the link you provided

tanks for the feedback

Guy M. Lerner said...


Can you provide the link again, please?

Anonymous said...

The increase in bond yields is a message from the financial community, China, and Japan to the administration they didn't, and don't, like this continual spending after promising to make all further expenditures revenue/cost neutral. The health insurance care bill is NOT cost neutral! "Get your act together or we will demand more risk yield". If the 109 already passed bills that are to be attached to the healthcare insurance bill, do increase the expenditures, US bond and note interest rates will be forced upward by bond/note buyers. This will force Ben to increase the Fed rate which will further increase the street's inflation rate, then the few workers left will ask for pay increases, etc. etc. Ben is very very busy this moment monitizing the debt - isn't he?

D-man said...


Did you manage to access the link I provided?

here it is again