Bearish Signals from Bonds and Commodities on Stocks

Sep 29, 2007: 3:00 PM CST

Often, technical analysis alone is not sufficient to analyze properly the movements in the broad market Indexes, like the S&P 500 or the Dow Jones Index. Traders benefit from the larger picture of analyzing broader, interconnected perspectives from studying inter-market relationships and how markets are often intertwined, and send signals ahead of each other.

Without delving too deeply into the relationships, a summary is the following:

Bond prices tend to move relatively ‘in step’ with stocks, yet often lead stock market turning points by three to six months.

Commodity prices (related to inflation) tend to move opposite of bond prices (and – of course – similarly to bond yields).

The US Dollar also tends to move in the opposite direction to broad based commodities (again, inflation).

In terms of leading markets, we sometimes see commodities lead bonds due to the interest rate cycle, and bonds often lead stocks.

What’s happening at a glance right now?

Don’t get overwhelmed by looking at this chart, but note only the following developments:

  • Commodities – BLUE LINE – have rallied extraordinarily sharply in the last month
  • Bonds – PURPLE LINE – have turned down, reflecting the recent ‘cut’ in interest rates
  • The US Dollar – GREEN LINE – has quite obviously and sensibly fallen as a result of the rate cut
  • The Stock Market – RED LINE – has rallied quite sharply since early August

The sharply rising commodities prices are not a good sign for US Equities, at least in the short-term. This tends to be inflationary, and higher inflation tends to weigh down consumers and the general economy. In fact, the Federal Reserve is very vigilant about letting inflation get out of control.

Cutting interest rates in a period of rising inflation… it’s probably not a good idea.

The next chart is a little complicated, but focus – for now – ONLY on the green dotted line and red dotted line.

What I am trying to show in this chart is that BOND PRICES LEAD STOCK PRICES by a short lead.

Let’s see if I can convey this in the next chart:

BOND PRICES ($USB Index): BLUE
STOCK MARKET (Dow): BLACK

What’s happening is that the May to June “red line” decline in Bonds (blue) corresponded DIRECTLY to the red line decline in stocks from August to mid-August.

The Mid-June Green Line in Bonds (Blue) corresponded directly to the recent rally in stocks from early August until now.

Bonds subsequently rallied much further from August 13th to September 10th, suggesting potential FURTHER UPSIDE for US Equities… but look what has happened recently.

Bonds have turned DOWN in early September as a result of the Federal Reserve Rate Cut, which could be a bearish short-term signal for US Equities.

To understand the chart better, focus on the black line as Equities, and Blue Line as Bond Prices. Understand that bond prices lead the stock market and use that as a guide in reading the chart.

Summary:

With the rampant rise in commodity prices, subsequent decline in the US Dollar, recent downturn in the bond market… we can likely expect lower prices (but not significantly so) in the US Equities market.

 

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