BOND AND STOCK DECOUPLING MAY CARRY WARNING -- PRICE AND TIME TARGETS FOR CYCLICAL BULL MARKET HAVE BEEN REACHED
DROP IN BOND YIELDS HURTS STOCKS... I wrote a column on Wednesday describing some similarities (although on a smaller scale) between the current market and the one in the spring of 2000. I was talking mainly about sector rotations out of technology into defensive groups like oil, consumer staples, utilities, and REITs that took place four years ago and -- to some extent -- are taking place now. There's another similarity between now and the spring of 2000. Bonds and stocks are decoupling again. In the spring of 2000, bond yields started to fall and bond prices rose. Stocks also fell. In that instance, the drop in rates was signalling economic weakness which actually hurt stocks. Since the surprisingly weak jobs report last Friday, bond prices have jumped and yields have dropped sharply. Chart 1 shows the 10-year T-note yield tumbling to the lowest level in eight months. Normally, the drop in rates would be bullish for stocks. But so far they haven't been. Over the last week, the stock market suffered its biggest decline in a year. Chart 2 shows the S&P 500 tumbling to the lowest level of the new year. That's of some concern. Because it suggests that the plunge in yields is warning of some economic problems. If that's the case, that may not be good for stocks. So far, the decoupling of bonds and stocks is only short-term in nature. But it's worth paying attention to. The last time we saw this happen four years ago, the drop in bond yields wasn't a good sign for stocks.
Chart 1
Chart 2
NASDAQ CORRECTION BEGINNING FROM RESISTANCE BARRIER... Since the recent stock market correction started with the Nasdaq -- and that's where the biggest decline has occurred -- we're going to study its long-term trend more closely to help put the recent selloff in perspective. First of all, notice that the January 2004 peak took place near the early 2000 peak around 2100. [The Dow also stopped rising at its early 2002 peak]. That's a logical spot for a correction to start. During January, the 14-week RSI formed a "double top" over 70, which is overbought territory. The RSI line has fallen to the lowest level in a year. The weekly stochastic lines are also falling to the lowest level since last spring. Both indicators suggest that the current selling is more that just a short-term pullback. The next key support level to watch is the (red) 40-week moving average which is just below 1900. I suspect that long-term support line will be tested. That will be an important test. Whether or not that long-term support line holds will determine if the current correction is just an "intermediate" setback or something more serious.
Chart 3
CYCLICAL BULL HAS REACHED PRICE AND TIME TARGETS... Last summer in a Market Message entitled "A Cyclical Bull in a Secular Bear" (June 20, 2003) I expressed the opinion that the new bull market was "cyclical" in nature. That meant that it would be shallower and shorter than bull markets seen over the last twenty years (when the "secular" trend was up). I provided some upside price and time targets that are worth revisiting. Based on research provided by Ned Davis, cyclical bull markets normally last about year and the S&P 500 normally recovers about 50% from its bottom. To quote from that earlier message: "A 50% rally off the lowest low yields a target to around 1150". As the chart below shows, that target has been hit. The time target is less precise and depends on which lowpoint is used. Since there are three time troughs, there were three possible time targets for a market top. The first two were last July and October since that's where the first two troughs were located the year before. Both of those two time targets have long passed. To quote again, however, "A third possibility is next March (2004) since that's where the latest rally started from". I'm revisiting that analysis now because the last time target has been reached for a possible top. Add to that the fact that the upside price target in the S&P 500 has also been reached and the analysis becomes more compelling. I'm also struck by the fact that this last week was the first anniversary of last year's March bottom and the fourth anniversary of the March 2000 top. Markets have a way of changing direction on anniversary dates. In my opinion, the preceding data is enough to warrant a more cautious stance on the market.
Chart 4
