Long-Term Charting the Strong Relationship Between Stocks and the 10 Year Treasury Yield

Aug 19, 2011: 9:28 AM CST

Since uniting in 1998, US Equities have displayed a strong positive relationship with the 10-Year Treasury Note Yield, and we can gather insights from that relationship.

Let’s start with the monthly frame and work down to the daily chart to assess the relationship and the current signals from this important Inter-market Pair:

There’s a little trick to the relationship – at major market turns, the Bond (Yield) market has led (preceded) turns in equities.  This tendency is more pronounced at key market tops (peaks) than bottoms, however.

I highlighted these advance turns on the chart above – they appear as large-scale negative divergences in the Treasury Yield when compared with the corresponding peak in stock prices.

For reference, in all charts, the 10-Year Treasury Yield is blue and scaled on the right side of the chart in terms of yield (where 40 equals 4.0%; 30 equals 3.0%).  The S&P 500 is simply colored red and scaled on the left side of the chart.

It’s also important to note that, while the correlation holds up, the Ten-Year Yield is actually in a structural, long-term (multi-year) downtrend which you can see on the chart above.

As equities in 2007 reached their 1,550 peak created in 2000, the 10-Year Yield registered a lower high near 5.0% – down from the 6.5% level observed in 2000 at the equity peak.

Similarly, as stocks challenged the 1,400 level in 2011, the 10-Year Yield peaked at 3.5%.

This long-term downtrend is helpful in putting the recent “all time low” in the 10-Year Yield into a bigger-picture context.

Let’s now drop to the Weekly Chart to see how the relationship fared in the Bear and Bull markets of the last few years:

While the 10-Year Yield technically peaked in early 2006, the second peak – which corresponded with equities – actually registered in June 2007, four months ahead of the fateful October peak in stocks.

Again, it’s important to spot these early-leads (divergences) in the Yield when compared to stocks at potential major turning points.

The Yield followed equities lower through the deteriorating economic conditions/crisis of 2008, ending in December 2008 again three months ahead of the stock market’s ultimate bottom in March 2009.

The Yield traveled higher with stocks, forming a barrier of resistance at 3.8% as the first round of Quantitative Easing ended in early 2010 – ahead of the Flash Crash.

Based on the chart-scale above, the real crash wasn’t really in equities in mid-2010, but in the Treasury Yield – falling almost 40% to bottom at 2.4% as the second round of Quantitative Easing was announced.

Here’s where it gets interesting in today’s perspective.  The Yield followed stocks higher, but diverged again (formed a lower peak when equities formed a higher peak) into the April/May 2011 high.

It doesn’t take much imagination to see what happened next in stocks – it’s been all over the headlines:

The Daily Chart clarifies the picture, with the 10-Year Yield peaking in February at 3.7% then forming a lower peak in April at 3.6% while equities went on to make its final top just above 1,350 on May 2nd.

During this time, the Yield began its descent and stocks soon followed.  There was one more rally in July which ultimately was a trap ahead of the collapse in the stock market – along with a 33% fall from 3.0% to 2.1% of the Treasury Yield.

The Treasury Yield is beneath its October 2010 low of 2.4%, but that belies another fact that arises from the monthly/weekly view:  The 1o-Year Treasury Yield nipped beneath its lifetime bottom near 2.1% that formed in December 2008 at the heart of the financial crisis.

Take the whole picture in its long-term context in light of historical developments/outcomes and use those insights to the current structure.

Here are a few prior posts on the important comparison of Stocks and Yield:

Charting the Breakdown in 10-Year Treasury Yield and Stocks August 2″ (a boring title but a post that forecast the stock collapse)

The Ten-Year Note and the Yield Curve” April 19th, 2011

“QE2 and Technical Analysis Signals in the 10-Year Yield”

Comparing the 10-Year Yield and SP500 During Recession and Recovery

Want Clues to Likely Stock Market Reversals?  Watch TLT and IEF” (popular bond funds that are opposite yields).

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

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Comments
  • Jasneet Wadhwa

    Thanks for the interesting and excellent tutorial. Would like to share it on my blog. Incase you do not approve email me pls.

    regards

    Sim

    http://mcx-advisory.blogspot.c...

  • Meg

    Thank  you Corey,   it was an "excellent" tutorial and is much appreciated!!

  • beantowntrader

     Corey,

    Your last statement leads one to believe that the S&P has some more follow thru to the down side. The 10 yr has yet to see a bottom so not a good sign for the immediate economy. I hope the FED has this correlation in there studies of how effective QEs are to the equities market. Bravo Corey for another amazing analysis. Keep up the great work!

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