STEEPER YIELD CURVE CAUSED BY RISING BOND YIELDS IS A GOOD SIGN FOR STOCKS AND THE ECONOMY -- BOND YIELDS AND STOCKS HAVE BEEN TRENDING TOGETHER FOR THE LAST DECADE -- MONEY COMING OUT OF TREASURIES IS MOVING INTO STOCKS AND CORPORATE BONDS

TREASURY YIELDS HAVE BOTTOMED ... The stock market is a leading indicator of the economy. Historically, stocks usually bottom about six months before the economy. With a stock bottom having formed in March, that leaves a time target for an economic bottom by September. Rising stock prices are one of the reasons the index of leading economic indicators has risen for the third month in a row. The biggest contributor to this month's LEI gain, however, comes from a steepening yield curve. That's the spread between short- and long-term interest rates. Since short-term rates are being kept down by the Fed, the jump in the yield curve is coming almost exclusively from rising long-term rates. That also carries good news for stocks and the economy. [Market tops are usually characterized by an inverted or flat yield curve after the Fed has raised short term rates; market bottoms see a steeper yield curve resulting from the Fed's lowering of short-term rates]. Rising bond yields, therefore, suggest a number of positive things going on. The most obvious is that money leaving the safety of Treasury bonds is moving into stocks (falling bond prices push bond yields higher). That's a sign of growing confidence. And it does look like bond yields have bottomed. Chart 1 shows the 10-Year Treasury Note Yield having broken a two-year resistance line drawn over its 2007/2008 highs. The TNX has also exceeded its 200-day average as has its 50-day line. The TNX peaked in mid-2007 along with stocks as money rotated out of stocks and into Treasuries. The 2009 upturn in bond yields suggest just the opposite.

Chart 1

BOND YIELDS AND STOCKS TREND TOGETHER... During most of the postwar era, rising rates were considered to be negative for stocks. That hasn't been the case since 1998 however. A deflationary threat that started with the 1997-1998 currency crisis caused a major decoupling of bond and stock prices. As my 2004 book on intermarket analysis points out, deflation causes bond prices to rise while stocks fall. That's why bond and stock prices have maintained an inverse relationship in the last decade. That also means that bond yields (which move inversely to bond prices) have been rising and falling with the stock market since 1998. That's what Chart 2 shows. The price bars measure the trend of the 10-Year Treasury Note Yield. The green line is the S&P 500. You'll notice that both peaked during 2000 and turned up in 2003. Both peaked again during 2007 and now appear to be bottoming together. The jump in bond yields also suggests that deflationary pressures are easing. The weaker dollar and bouncing commodities suggest the same thing. There's another positive rotation going on within the fixed income sector. Another sign of growing confidence comes from rotation out of Treasuries into risker bond categories like corporate bonds.

Chart 2

ROTATION TO CORPORATE BONDS ... Chart 3 shows that falling Treasury note prices (gray line) have coincided with rising corporate bonds (green line). The green line (LQD) is an exchange traded fund that tracks investment grade corporate bonds. Similar gains have occurred in high-yield corporates and Treasury Inflation Protected Bond (TIPS). That shows that investors are willing to assume more fixed income risk (and are becoming more concerned about inflation than deflation). The same story is told by Chart 4 which plots a ratio of the Investment Grade Corporate Bond ETF (LQD) divided by the 10-Year Treasury Note ETF (IEF). The ratio peaked in mid-2007 when fixed income money moved into Treasuries as the stock market was peaking. The ratio has already broken a two-year resistance line which confirms that the tide has now turned away from Treasuries in favor of corporate bonds. That's another sign of investor confidence. It's also another reason why rising Treasury bond yields are a good sign for the stock market and the economy.

Chart 3

Chart 4

S&P 500 APPEARS HEADED TO 1000 LEVEL... The market is off to a strong start for the week. As a result, the S&P 500 is retesting its summer high at 956 as shown in Chart 5 (see box). An upside breakout appears likely. That would put the next upside target at its early November peak near 1000. That would also represent a 50% rally from its March low at 666.

Chart 5