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What is the wild bond market saying about the stock market?

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Summary:
While the stock market’s decline isn’t extreme by any means, other related markets seem to show heightened fear. The correlation between stocks, bonds, and gold has been strong recently. Risk-on days see stocks & yields go up, while gold falls. Risk-off days see stocks & yields go down, while gold rallies. Today’s headlines: Double volatility spikes Stocks & bonds: part 1 30 year bond yield sinking to a new low Both yield curves Stocks & bonds: part 2 Go here to understand our long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day. Double volatility spikes Here’s how a correction usually plays out: The first wave in which the S&P goes down, VIX explodes and makes a high. But as the S&P keeps going down, VIX’s spikes

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While the stock market’s decline isn’t extreme by any means, other related markets seem to show heightened fear. The correlation between stocks, bonds, and gold has been strong recently. Risk-on days see stocks & yields go up, while gold falls. Risk-off days see stocks & yields go down, while gold rallies. Today’s headlines:

  1. Double volatility spikes
  2. Stocks & bonds: part 1
  3. 30 year bond yield sinking to a new low
  4. Both yield curves
  5. Stocks & bonds: part 2

Go here to understand our long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day.

What is the wild bond market saying about the stock market?

Double volatility spikes

Here’s how a correction usually plays out:

  1. The first wave in which the S&P goes down, VIX explodes and makes a high.
  2. But as the S&P keeps going down, VIX’s spikes make lower highs.

VIX spiked more than 15% today, just 5 days after last Monday’s spike. However, VIX’s spike set a lower high.

What is the wild bond market saying about the stock market?

When this happened in the past, VIX usually fell over the next month.

What is the wild bond market saying about the stock market?

However, this isn’t consistently bullish for the S&P in the short term. As I said last weekend, stock market corrections usually see more than 1 DOWN wave, even if VIX doesn’t make a higher high.

What is the wild bond market saying about the stock market?

Stocks & bonds

The stock market’s recent decline is not extreme. However, a lot of the extremes have occurred in safe haven markets. For example:

  1. Gold’s sentiment is high, yet it continues to rally.
  2. Treasury bond sentiment is extremely high, yet Treasury bonds continue to rally (yields continue to fall).

This usually happens when a very strong “theme” emerges. This theme can swamp contrarian indicators in the short-medium term. (The obvious current theme is “trade war”). Bloomberg captured this theme and the accompanying contrarians with:

What is the wild bond market saying about the stock market?

Stocks have been trending upwards over the past few months while yields have completely collapsed. As a result, the S&P:10 year Treasury yield ratio has soared.

What is the wild bond market saying about the stock market?

This kind of surge almost always saw a bounce in Treasury yields over the next week…

What is the wild bond market saying about the stock market?

…and was bullish for stocks.

What is the wild bond market saying about the stock market?

What is the wild bond market saying about the stock market?

We’ll look at bonds from multiple angles in this post. The overall message is clear: when bond yields do rally, it will not be a bearish factor for stocks.

30 year yields

The 30 year Treasury yield has sunk to a 3 year low.

What is the wild bond market saying about the stock market?

When this happened in the past, the 30 year yield would often bounce in the short term. But what happened after that was a 50/50 bet. Once a trend gets going, it’s hard to know exactly when it will stop.

What is the wild bond market saying about the stock market?

And once again, this isn’t bearish for stocks after 1 month.

What is the wild bond market saying about the stock market?

Both yield curves

With bond yields falling, the 10 year – 2 year yield curve has come close to being inverted. This is interesting because:

  1. This time, the 10 year – 3 month yield curve inverted months BEFORE the 10 year – 2 year yield curve
  2. In the past, the 10 year – 3 month yield curve always inverted AFTER the 10 year – 2 year yield curve

So while the 10 year – 2 year yield curve was more widely watched in the past, the 10 year – 3 month yield curve was more accurate. But instead of picking 1 yield curve over another, we can just look at both of them.

What is the wild bond market saying about the stock market?

Here’s what happened next to the S&P when both yield curves were below 0.1%

What is the wild bond market saying about the stock market?

What is the wild bond market saying about the stock market?

Overall, the yield curve is a sign that long term risk:reward doesn’t favor bulls.

Stocks & bonds: part 2

From a multi-month perspective, it looks like the S&P and bond yields are moving in opposite directions.

What is the wild bond market saying about the stock market?

But on a day-to-day basis, almost all of the S&P’s gains have occurred on days when Treasury yield went up, and almost all of the S&P’s loses have occurred on days when Treasury yields went down.

What is the wild bond market saying about the stock market?
  1. Stocks and yields have a very strong day-to-day correlation.
  2. It’s just that on days when stocks go up, bond yields go up a little. But on days when stocks go down, yields crash. Hence on a multi-month basis, stocks and yields move in opposite directions.

Here’s this day-to-day correlation over the past 200 days.

What is the wild bond market saying about the stock market?

There are only 4 other periods in which the S&P went up more than 37% over the past 200 days when the 10 year yield went up, and fell when the 10 year yield went down.

What is the wild bond market saying about the stock market?

What is the wild bond market saying about the stock market?

Sample size is small, and not consistently bullish or bearish. But overall, this tends to happen around periods of major uncertainty in the financial markets:

  1. 2014: ex-U.S. currencies collapse, emerging market problems, commodity prices collapse
  2. 2007: clear housing market problems, stock market top
  3. 2002: after a big 2 year bear market and a recession
  4. 1998: after a -20% stock market crash

A sign of the times.

We don’t use our discretionary outlook for trading. We use our quantitative trading models because they are end-to-end systems that tell you how to trade ALL THE TIME, even when our discretionary outlook is mixed. Members can see our model’s latest trades here updated in real-time.

Conclusion

Here is our discretionary market outlook:

  1. Long term: risk:reward is not bullish. In a most optimistic scenario, the bull market probably has 1 year left.
  2. Medium term (next 6-9 months): most market studies lean bullish.
  3. Short term (next 1-3 months) market studies are mixed.
  4. We focus on the medium-long term.

Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward favors long term bears.

What is the wild bond market saying about the stock market?

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