What Are Bond Market Intermarket Relationships Saying About Inflation?

• The TIP/TLT Ratio reflects swings in commodity prices
• Watch that Technology/Staples ratio for a possible bullish breakout
• US breaking down against Global Equities

The TIP/TLT ratio reflects swings in commodity prices

When bond yields  are compared to commodity prices there is definitely a connection, as we can see from the matching green and red arrows in Chart 1. However, there are also periods when the two are moving in different directions or where, say commodities are moving sideways and yields higher, as in the period since last August. While we can say that most of the time there is a connection, there are sufficient exceptions that preclude one market from being blindly used to predict the other.

Chart 1

A better way to approach this is to use different opinions amongst bond investors themselves. In this instance, their preferences between regular bonds and inflation protected ones. Chart 2 compares the DB Commodity ETF with a ratio calculated from the iShares TIPS Bond ETF and Barclays 20-year Trust (TLT). The idea, is that when investors are feeling the need to protect their portfolios from inflation they bid up the price of the TIP against that of the deflation sensitive TLT.  You can see from the chart that this relationship also fails the “perfection” test, as bond investors occasionally make an incorrect guess about commodity prices. Sometimes the bond market ( i.e. the ratio) leads and at other turning points commodities go first.

Chart 2

Chart 3 features the same securities but this time I have drawn in a couple of trend channels and we can see that both series are very close to a downside (deflationary) breakdown. Also, the KST, in the bottom window, has just triggered a sell signal, thereby adding to the deflationary weight of the evidence.

Chart 3

In Chart 4 we can appreciate that the recent trading range is quite small when considered from a longer-term perspective. In effect the ratio is currently trading just below some massive long-term resistance flagged by the two converging trendlines and the upper band of the recent trading range. While it could well sell-off in the next few weeks it would have to experience a lot of downside action to result in a negative 200-day MA crossover or a drop below the signal line for the Special K indicator. That suggests that any near-term inflationary weakness is likely to represent a correction under the context of an overall primary bull market.

Chart 4

Finally, we see from Chart 5 that a similar measure for global bonds is also below key resistance. This time we are comparing the Citi International Government Inflation Protected Bond ETF (WIP) with the Barclays International Treasury ETF (BWX). This relationship is very close to an upside breakout. If one develops that would suggest that international bond investors are placing their bets on a global inflationary outcome. It’s interesting to note that prior to 2012, both series were essentially moving in the same direction. However, since then the global ratio has been firmer than that for the US, in the lower window. That suggests that anecdotally, inflation is likely to be more of a problem outside than inside the US.

Chart 5

Watch that Technology/Staples ratio for a possible bullish breakout

A very useful relationship that guides us, as to when investors are optimistic or lack confidence, comes from the ratio between the Spider Technology ETF and the Consumer Staples ETF’s. When the ratio is rising it indicates that investors are in a confident mood, because they are favoring the more speculative technology issues over the defensive consumer staples. Conversely, a lack of confidence is signaled when they flock to the higher yielding and more predictable earnings streams associated with consumer staples. Little wonder, that the shaded areas in Chart 6 show that a rising ratio is typically associated with a buoyant S&P and vice versa.

Chart 6

Chart 7 tells us that the ratio recently broke out from a major base, the top of which has been flagged by the dashed green line.  It is currently just below and even longer resistance trendline. That line looks as if it may soon be violated because the objective from the initial breakout at 1.4, is well above its breakout level. The long-term KST for this relationship is also in a rising trend, which augurs well for an upside breakout. The implications are very positive because the bases are extensive. For example, the breakout that has already taken place comes from a pattern of 8-years duration, whereas the potential formation is 16-years and counting.

Chart 7

Chart 8, shows that the ratio is very close to a possible upside breakout, as it is right at a resistance trendline. Both momentum indicators are also at resistance, so it’s quite possible that we might see an extension to the post July uptrend. The signal for this would be a daily close in the ratio above .97. Remember, you can always click on the chart to have it updated. You can also save the chart and add it to a chart list, so it’s a permanent part of your chart library.

Chart 8

US breaking down against Global Equities

Last week I raised the possibility that the trend favoring US equities against the rest of the world could be in the process of reversing. Chart 9 displays the ratio between the S&P ETF, the SPY and the Vanguard World ETF Ex the US (VEU). This week it tentatively violated its 200-day MA and the up trendline emanating in early 2015. All three KSTs are in a declining mode of some kind, so it seems likely that US equities will be extending their very recent trend of underperformance. Major support lies at the solid horizontal trendline, so it’s possible that any downside could be halted there. However, with a negative 200-day MA and up trendline violation, as well as a series of declining peaks and troughs, and a bearish long-term KST, the odds favor a primary bear trend against the US, or at best an extended trading range.

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.