Research.LeutholdGroup

In the May Green Book, and again in the May 21st issue of “Chart of the Week,” we discussed the trailing one-year correlation between weekly percentage changes in the S&P 500 and the 10-year Treasury bond yield. Rollovers from high levels in this correlation have signaled most of the important pullbacks in the bond market over the last 20 years.

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After Consumer Price Inflation spiked to a 12 1/2-year high of 4.2% in April, there’s been a torrent of analysis decrying the collapse of “real yields”—including the real Treasury-bond yield, real S&P 500 dividend yield, and even the real S&P 500 earnings yield. Since all of these yields already traded at extremely low nominal levels, the inflation adjustment makes every one of them look even worse. For example, the real yield on 10-year Treasuries just sunk to -2.60%, the lowest reading since 1980 (Chart 1).

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The 10-year Treasury yield has absorbed the past two months’ worsening inflation numbers by going exactly “nowhere.” Bond investors seem to be all-in on the Fed thesis that the inflation pickup is just transitory.

During the recent consolidation, however, the Treasury yield showed a subtle change in character—one that suggests there might be more inflation paranoia than meets the eye. The 10-year yield’s daily correlation with stock price movements flipped negative, and then plummeted toward a 21-year low. 

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The S&P 500 and 10-Year Treasury bond yield could accomplish something fairly rare today by closing at “joint” 52-week highs. The relevant levels to meet or exceed are 3934.83 on the S&P 500 and 1.49% on the bond yield.

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With yields on the 10-Yr. Treasury finally breaking above 1.00% last month, the consensus has quickly evolved to the view that stocks and yields can continue to rise alongside one another for a while. Small Caps have shown a decisive performance edge during the recent episodes.

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We studied several “popular trades” and there are good reasons to be on board with most of them, but none can be viewed as a no-brainer.

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It would be a mistake to ignore (as most pundits will) this important forecasting tool until the next time it threatens to invert. The level and direction of the yield curve provide helpful information throughout the entire economic cycle.

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When we first met Steve Leuthold in the old company office in a renovated warehouse, he was updating a several-foot-long chart of either the DJIA or S&P 500, by hand, and we got a brief lecture on the importance of using logarithmic scale on price charts.

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The collapse of U.S. Treasury yields and the simultaneous end of the bull market has produced a new all-time record for the S&P 500, albeit under less-than-desirable circumstances.

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In our minds, the big story is not the nominal new highs in the blue chips, but rather the rapid changes now occurring on both an “intra-market” and “inter-market” basis. In the case of the latter, we have an important new signal from a simple correlation model we developed earlier this year.

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The bull market took out another old record last month when the S&P 500 topped the cumulative total return of the 1949-56 upswing. The total return since March 9, 2009, is now 468%. Since the highs of March 2000, the S&P 500 cumulative total return is actually a few basis points behind U.S. 10-year Treasury bonds.

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The fear (or hope) that U.S. bond yields would fall to zero or below subsided over the last month. However, the belief that low yields merit significantly above-average P/E ratios remains stronger than ever.

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We’ve never understood investment quants’ desire to project correlations among assets. Such correlations are inherently unstable.

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The pattern of sharp sell-offs followed by equally sharp rallies continued in June. Most risky assets recouped nearly all the losses suffered in May, and then some.

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Many economists believe U.S. economic growth will reaccelerate in the second half, sending 10-year Treasury bond yields back above 3% late in the year. A forecasting technique with an excellent record, however, suggests the return to 3% won’t occur until late next decade!

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Signs of spring are popping up everywhere in the Financials sector. S&P Financials was easily the top- performing sector in April and several sub-industries have been bubbling higher in our Group Selection discipline.

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In September the popular claim was that “interest rates were rising for the right reasons,” and still too low to threaten stocks or U.S. economic expansion.

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It’s been one of the worst years on record for diversification, with our hypothetical All Asset No Authority (AANA) portfolio down 7.2% YTD through yesterday. That’s the second-worst year for AANA since 1972, and there’s probably not enough time left for performance to undercut 2008 (-24.9%) for the bottom spot.

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Doubling of yields since 2016 has slammed households. Percentage increase in rates is more important than the absolute level.

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Having devoted all of our professional lives to the monitoring and modeling of equity markets, we’re naturally ticked off that this year’s best stock market signals have in fact been rendered by bonds.

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A couple of months ago, we (belatedly) observed that, in February the 10-year Treasury yield had bro-ken above its 10-year moving average. That simplistic tool has been a pretty good descriptor of yields’ long-term trend for more than a century, with few “whipsaw” signals along the way.

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In recent commentaries, we’ve highlighted the surprising number of U.S. stocks making 52-week lows on both a daily and weekly basis, a sign that the market’s push higher has become more fractured. While pondering the significance of those lows, however, we missed a new 52-week high last Friday in a series we think will be especially critical to the stock market’s near-term fortunes: the 10-year U.S. Treasury bond yield. Specifically, the yield matched its weekly closing high of 3.07% posted on May 18th.

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In the past year, big-name bond gurus have put forth various yield targets that, if exceeded, would provide definitive proof that the secular bull market in Treasury bonds begun in 1981 had finally ended.

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While a plunge into a recession could always result in a final “blow-off” phase to the 35-year secular bull market in bonds, any youthful, long-term buyer of 10-Year Treasurys should weigh that exciting possibility against the odds that bonds do no more than match the inflation rate over the next 30-50 years.

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The travails of active equity managers have been well-documented throughout the year, but there’s been little attention paid to the 2016 plight of economic forecasters—especially ones unlucky enough to have been accurate.

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In mid-summer we suggested that attaining new market highs would probably require a rotation away from the long-time Low Volatility market leaders and into High Beta areas like Technology and industrial cyclicals.

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Yields on 10-Year U.S. Treasury bonds sunk to an all-time low of 1.37% on July 5th, yet so far there’s been a mysterious absence of contrarians willing to step up to say that “the” secular low in bond yields is at hand.

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We’re tactically bullish, but among the twelve “Charts That Worry Us” published in the April Green Book, we’ll concede there are a few that still worry us.

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We like to think our models and indicators help us preserve a high degree of market objectivity. But sometimes we wonder: the latest rally has progressed to the point where we see trouble afoot in both the strongest and weakest charts we can find.

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