When it comes to inter-market analysis, there’s something I always think of: Bear Stearns Company. More specifically than the company, I think of the letters BSC as a reminder of a very common phrase: Bonds lead stocks lead commodities. Typically this would be leading as in higher and lower. Could it also lead inversely?
I have recently written (2) Chart School newsletters in regards to potential breakdown of the stock market. These newsletters highlighted a very long-term Dow channel and a very important support line for the S&P. Well, if bonds lead stocks, could bonds give us a heads up?
Please review the TLT (iShares 20 Year Treasury Bond Fund) ETF chart below with my notations:
While the stock market has rallied higher over the last 6 months, bonds as illustrated by the TLT have sold off. This same inverse correlation also existed when the stock market sold off from April to August, while bonds rallied during that same time frame. If you notice the TLT above, you will see it has been stuck within a downward channel. Yesterday, the TLT broke out through the topside of this channel indicating potential higher prices for bonds. Summing up, if bonds and stocks are moving inverse to one another, and bonds lead stocks, then could the TLT’s breakout signal and eventual stock market breakdown?
The Tale of the Tape: Yesterday I wrote about a very important channel resistance that has come into range on the Dow and today I wrote about a very important S&P support line. Bonds and stocks have been moving against one another and bonds can tend to lead stocks. Yesterday’s breakout of the TLT seems to be signaling a move higher in bonds, which in turn would signal a potential move lower in stocks. Already knowing that the Dow was at a very important resistance, we could be seeing a major move unfolding.
What to do? If you like what you see in my charts, buying the TLT or UBT would make sense. You could also short the TBT. If bonds move higher, I’d expect rates to move lower which should favor the dollar and hurt the euro. So, you could also buy the UUP, short the FXE (euro) or buy the EUO. Upon purchase/short, make sure to set a stop below the breakout/breakdown point in case the market still has some steam and is faking us out yet again.
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. Capital preservation is always key!
Christian Tharp, CMT