A Funny Thing May Have Happened To The Secular Reversal In Rates

• The Secular Bear Market in Yields
• Near-Term Indications of a Decline in Bond Yields
• Watch That Stock/Bond Relationship for an Important Signal

The Secular Bear Market in Yields

Please note that the comments in this article relate to bond yields with maturities of 3-years or longer. They do not apply to money market yields, which are controlled by the Fed.

Charts 1 and 2 show that the bond market has reached a very important juncture point. The 3-year yield, for instance, bottomed in 2012 and subsequently experienced a series of rising peaks and troughs. This, together with the widest deviation from its 96-month MA in the period covered by the chart, argues for a secular trend reversal from bear to bull. The one missing ingredient is a break above that green 1981-2018 secular downtrend line. There are several reasons why this break is likely to be postponed for a while. First, the line represents significant resistance, having turned back five rallies already. Moreover, the KST has started to peak. That suggests upside momentum is dissipating. We see similar flattening action with (1/96) PPO in the bottom window.

Chart 1

Chart 2 indicates that the 10-year yield has also rallied back its secular bear market trend line. In fact, it broke through in October, but fell back below the line in November, suggesting that the break may turn out to be false. Its KST is also very close to crossing below its MA and therefore triggering a sell signal. Unlike the 3-year yield, which bottomed in 2012, this series edged out its 2012 bottom in 2016. I fully expect it to eventually complete the secular reversal process. However, previous trend changes have almost always been characterized by an extended trading range; the current technical position suggests that the 2011-18 base-building period is likely to extend.

Chart 2

Near-Term Indications of a Decline in Bond Yields

Chart 3 offers some proof in that direction. The 10-year yield, for instance, has violated its 2016-18 uptrend line. In addition, the short-term KST (in the center window) is bearish. Moreover, its weekly long-term counterpart, which is more sensitive than the monthly series in Chart 2, is extremely close to a sell signal.

Chart 3

Another reason for expecting lower yields lies in the fact that confidence among bond traders has started to deteriorate. That point is demonstrated in the center window of Chart 4, which features the ratio between junk and treasury bonds. A rising ratio means that investors are confident, as they are bidding up the prices of high yield junk over the far more defensive treasuries. A falling relationship tells us that their preference is for treasuries, as fears of growing defaults becomes more real. For that reason, swings in the ratio correlate nicely, but far from perfectly, with the 10-year yield itself. A couple of weeks ago, the ratio violated its 2016-18 uptrend line, thereby confirming the trend break in the yield.

It’s interesting to see that the long-term KST for the ratio has gone bearish. The two previous KST sell signals, marked with the blue arrows, were both followed by a substantial drop in confidence and the 10-year yield.

Chart 4

Chart 5 shows the Barclays 7-10-year ETF (IEF) together with its Special K indicator, which you can read about here. Ignoring the false upside break in mid-2017, the price has now decisively violated its 2016-18 downtrend line. The Special K has violated a similar downtrend line and crossed above its red signal line. All of this suggests that the price stands a good chance of breaking above the top of its 2018 base flagged by the dashed green trend line.

Chart 5

Watch That Stock/Bond Relationship for an Important Signal

We have heard a lot about rising rates eventually affecting equities in an adverse way, but these are mostly opinions that are not backed up with facts. It seems to me that the time to get worried about a rising rate scenario is when stocks demonstrate this sensitivity to rate hikes by under-performing bonds.

In this respect Chart 6 shows that the ratio between the S&P Composite and the 30-year bond price ($USB) has led the last three tops in the S&P. The KST for the ratio is shown in the bottom clip. The red arrows point out the fact that downside KST reversals are typically followed by some form of corrective action in the stock/bond relationship, usually transmitted to the S&P itself. Right now, the KST is in the process of crossing below its MA, which signals a likely pause or decline in the ratio itself.

Chart 6

Finally, Chart 7 shows a slightly different relationship, that between the unadjusted S&P ($SPX) and Barclays 20-year Trust( TLT). This daily price action has already violated the dashed uptrend line, which signals a slowing down of upside momentum. That’s also the picture being offered by the Special K. It looks very much to me as if the trend line/Special K combination is exactly the opposite of the bullish signal developed in the fall of 2016. The key is to obtain some more confirmation from the ratio itself. It looks as if it is in the process of forming a complex head and shoulders top. That formation would be completed with a daily close that can hold below 22.5. If that happens, it would represent another piece of bearish equity market evidence.

Chart 7

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.