Tuesday, December 7, 2010

Rising Yields Are Both Good and Bad for Equities

Rising long term Treasury yields can be viewed as a sign that the economic recovery is taking hold.  That is one interpretation.  Another is that rising yields will serve to pressure equities and choke off any rally that may develop.  I believe the latter scenario will eventually predominate as there is a limit to how high equity prices can rise in these liquidity fueled rallies.

Figure 1 is a weekly chart of the Ultra Short Lehman 20 + Treasury Bond Fund (symbol: TBT).  This 2 x leveraged ETF moves inverse to bonds or in the direction of yields.  I have been writing about higher Treasury yields since October 15, 2010 when TBT was at 32.39.  Since then, TBT has hit and struggled to get above the initial level of resistance at 36.26.  A weekly close below 36.26 has been associated with market weakness, but last week prices on the TBT ended higher than this resistance level supporting the notion that the rally in equities was for real.  In the short run, long term Treasury yields have tracked equity prices.

Figure 1. TBT/ weekly

But as I have shown in the past, there is a limit to this dynamic.  As some point in time, rising yields will serve as a headwind for equity prices.  The strength in yields as shown by TBT's close over a weekly resistance level is confirmation of the recent equity rally.  However, this dynamic has its limitations, and higher yields will serve to choke off the equity rally.     

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