Traders insisting on a stock-centric approach can sometimes miss clues residing outside the realm of equities. While any major momentum shifts will undoubtedly reveal themselves in the price of stocks, sometimes significant moves in other asset classes serve as early warning signs of an impending change in stock land. By keeping tabs on these inter-market relationships, traders gain access to information that will either corroborate their current bias on equities, or perhaps give them sufficient reason to modify their outlook.
Take the strong inverse relationship between stocks and bonds for instance. While stocks are part and parcel of the “risk on” trade and head higher anytime risk appetite is on the rise, bonds sit firmly in the “risk off” camp and are sought after when safety is deemed paramount.
The volatile behavior of stocks in 2011 did little to soothe the jittery investor, leading many into the welcoming arms of bonds. In fact, the 20-Year+ Treasury ETF (TLT) ended up over 28% on the year providing all sorts of goodies to those clairvoyant enough to jump aboard the long bond trade. Interestingly, the bulk of the gains occurred in the August – September time frame concurrent with the failure of the US to reach the debt ceiling deadline and the subsequent S&P downgrade of the US debt rating from AAA to AA+.
The bond bull seems to have entered sleep mode since the beginning of Q4 2011. Whether or not the last three months of consolidation end up serving as a launching pad for yet another surge higher remains to be seen. A much better scenario for those rooting for higher stock prices would be a breakdown in bonds and subsequent trend reversal. As evident in the chart below, the 50 day moving average along with the highlighted trendline has provided support for bonds over the last three months. If the TLT can finally breach this key support level, lower bond prices may provide a much needed boost to stocks.
Picture the financial markets as one giant puzzle with different assets acting as the individual pieces. The size of each piece varies depending on its importance in revealing the final picture. Sometimes the individual pieces align to reveal a docile bull market, other times they combine to expose a ferocious bear market. Let’s just say if the intermediate uptrend in bonds can turn south, the picture begins to take on more of a bullish tone for stock prices.
Source: MachTrader
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