There are plenty of correlations between the various markets. Sometimes these correlations are direct, and sometimes they are inverse relationships. Believe it or not, sometimes correlations can switch from direct to inverse. There are correlations between interests rates and the dollar, the dollar and the euro, bonds and stocks, commodities and rates, etc. etc. etc. Sometimes these correlations are always in effect, sometimes they are in effect off and on, and sometimes they are only in effect from time to time. Obviously, it can be helpful to recognize when important correlations are in force that may give you a “heads up” to a trend change or continuation. So, let’s look at one correlation in particular: stocks vs. interest rates.
For this exercise I have chosen to use the S&P 500 to represent the markets and the 10 Yr. T-note for interest rates. Please analyze the 1-year chart of these below:
With the S&P above and the 10 Yr. below, you will notice that I have highlighted in blue some of the noticeable peaks in rates. You will notice that whenever rates turned down the S&P followed. More often then not rates led the market, with the market only leading once. So, why might this happen? Well, the simplest reason might be due to investors becoming fearful in their outlook on the economy. When this happens they tend to jump out of stocks in a “flight to safety, thus buying bonds. When the demand for bonds rises, so do bond price, which in turn pushes rates lower. In short, it could be useful to keep an eye on rates.
Below is a chart of the 10 Yr. T-note by itself with some key notations:
The red line denotes the down trending resistance for the 10 Yr Note. The green represents the key 3.10 level that is currently a resistance after being a long-term support. The blue support line at 2.90 is also a key level for the 10 Yr.
As of the time of this writing, with the markets moving slightly higher, the 10 Yr. has made its way through the down trending resistance. Since we have seen that there is a correlation between rates and the market, this resistance break would appear to make sense considering the market has also moved higher. Now the focus will be on 3.10 and 2.90. Remember, more often than not, rates on the 10 Yr. led the market. Regardless of which leads, paying attention to the 10 Yr. could help to confirm a higher or lower move in the market.
The Tale of the Tape: After breaking through its down trending resistance, the 10 Yr. T-Note is between its 3.10 resistance and 2.90 support. Watching these two levels to see which way rates break could help to confirm the future direction of the market. This in turn will help you know which side of the trade to be on and when to make those trades.
Waiting for the most opportune trading times, like I have outlined above, could provide you with the higher probability trading points. No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.
Christian Tharp, CMT