Bond Market Investing
Is a Death Cross Coming?
One of the greatest oddities of the U.S. stock market’s performance over the past four years since it bottomed in early 2009 is how equities and bonds have both risen together. Investors appear divided over where to put their money.
The U.S. Federal Reserve’s stimulus policy could be one cause, with low interest rates and bond purchases helping the prices of both stocks and bonds. Investors in both camps seem to be after the same thing – capital appreciation.
The difference between them is most likely over the underlying economic conditions: equity investors believe the ice is thick enough to skate on, while bond investors believe the foundation is still too thin.
“Equitarians” simply cannot understand how “bonders” could be so content with such limited capital returns from bonds when the Fed has seemingly taken the risk out of stocks. The bonders are simply biding their time as they await a peculiar signal from their charts.
The wait seems to be over. The signal is here: the dreaded “death cross”. The bonders may soon have an answer for the equitarians – “We told you so.”
The Bond Death Cross
The “death cross” spooks an instrument when its 50-day moving average drops below its 200-day moving average. Investopedia defines it so:
“As long-term indicators carry more weight, this trend indicates a bear market on the horizon and is reinforced by high trading volumes. Additionally, the long-term moving average becomes the new resistance level in the rising market.”
In perfect tandem with a rising stock market, bond prices steady fell from the middle of 2012 until the spring of this year, when the U.S. 10-year treasury yield rose to a recent high of 2.09%. Many were thinking the bond bull market was pretty much finished.
But at the beginning of March, investors once again turned to bonds, crunching the yield by half a percent in less than 2 months. The smart money undoubtedly timed the market. These investors most likely moved from bonds to equities in July of 2012, rode up the stock market advance into the spring, and in March began moving from equities back into bonds in anticipation of a summertime stock correction. It happens every year.
Only this time, the bond bulls had enough momentum behind them to drag the 10-year yield’s 50-day average (beige) dangerously close to its 200-day’s average (blue), as seen in the chart below.
Abigail Doolittle, a technical analyst at The Seaport Group, has seen these death crosses before and is firmly expecting “the historic running of the bulls in Treasuries will continue,” cites CNNMoney. “It may sound a bit sensationalistic,” she expounds, “but the bearish death cross has been an excellent predictor of the 10-year yield's significant slide over the last six years.”
Previous death crosses did not bode well for stock markets. The cross of September 2007 stopped the advancing stock market at its previous all-time high, which took over 5 years to reclaim. The cross of 2008 coincided with one of the largest stock market crashes U.S. history. And the crosses of 2010 and 2011 saw market corrections greater than 10%.
A Last Minute Reprieve?
However, since the beginning of May, a sharp reversal in bond yields prevented the death cross just in the nick of time. Was this signalling that bond traders had finally given up on bonds and were returning to stocks for good?
It seemed like it to many, prompting several analysts to call the bond bull run over. Even Mr. Bond himself, Pimco’s Bill Gross, tweeted on May 10th, “The secular 30-year market likely ended 4/29/2013.”
Indeed, April 29th and May 1st saw a turning point. For the following 2 weeks, bond prices fell and yields rose. But by the 15th, they stopped dead in their tracks. What happened?
All that bond selling from May 1st to 15th has been attributed to rumors that the Federal Reserve could begin reducing its bond purchases this summer and end them completely before the year is out.
But since then, others have dismissed those rumors. Federal Reserve Bank of St. Louis President James Bullard indicated he believes Fed bond buying should continue, as it is needed to further boost economic growth.
Thomas di Galoma, a senior vice president at New York’s ED&F Capital Markets, agrees. “I don’t see any real change in the QE intentions,” quotes Bloomberg Businessweek. “There’s no reason for bonds to sell off dramatically.”
A definitive answer to those rumors came today, when Federal Reserve Chairman Ben Bernanke spoke before Congress. He confirmed the continuation of the central bank’s bond purchasing program as is, and that recent retreat in bond prices will likely be just a calm before the storm.
Reaffirmation by the Fed that bond purchasing will continue will likely once again cause investors to flock to bonds, resume the buying of the past two months, and finally push 10-year treasury yields through the death cross and into bearish territory.
And they could take stocks down with them.
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It contains full details on something incredibly important that''s unfolding and affecting how gold is classified as an investment..
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Yield Spikes Precede Stock Corrections
This temporary reprieve of higher yields we have been seeing these past 3 weeks is itself a noteworthy signal of an impending stock market correction. Comparing the 10-year treasury yield to the S&P 500 index over the past 2 years shows at least 5 clear examples of rapid rises in yield (blue) just before stock corrections (red), as noted in the chart below.
At each bond sell-off (blue), there is a shifting of funds out of bonds and into equities, but only after stocks have climbed for a time and investors have become more comfortable with the market’s rise.
Then, when savvy investors see that fleeing bond holders have opened up a gaping yield behind them as they sold bonds, the smart money takes its profits out of stocks and stores them into bonds (top of blue meets top of red). An equity correction then ensues.
At the end of the stock correction (bottom of red), money then exits bonds after they have appreciated and rotates back into equities after they have corrected. The smart money then waits for equities to appreciate again, and the cycle resets itself for another go.
Currently, the rapid rise in bond yields these past two weeks (blue) has lifted the 10-year treasury MACD (orange) to a peak. In all 5 previous occurrences shown above, whenever a rapid rise in yield (blue) meets with a peak in MACD (orange), a stock market correction (red) begins within about 1 to 4 weeks.
Bound to Bonds
That the 10-year’s yield should be in danger of crossing below its 200-day average – or even anywhere near it – after 4 years of steadily improving stock prices is nothing short of astounding.
Clearly a large segment of the investing public is not convinced of an economic recovery. While equity mutual funds attracted some $71 billion of new investments this year, bond mutual funds received an estimated $86.3 billion.
Equity investors like Warren Buffet are baffled by bond investors. Buffett says he feels sorry for their having preferred the dismal returns of bonds over stocks these past four years. Even while the S&P 500 has risen some 146% since bottoming in March of 2009, equity mutual fund assets have grown by a mere 6.5% by this year’s Q1. Bond mutual fund assets, by contrast, have increased by more than 100% (more than doubled) to $3.5 trillion over that time.
Investment firms BlackRock and Western Asset Management believe bonds will continue to attract investments for at least the next two years, which corresponds to the time remaining on the Federal Reserve’s promise to keep interest rates unchanged at near-zero. Until the Fed starts raising interest rates again, bond holders are willing to ride it out to the end.
Indeed, investors will not be easily torn away from their security blankets made of bonds, and psychology may have a lot to do with it. “It’s basic human psychology,” Lee Spelman, head of U.S. equity managers at J.P. Morgan Asset Management explains to Bloomberg. “If you go through a year like 2008 it will take a while to get comfortable with equities again.”
Yet bond holders could be playing a little trick that would be difficult to spot amid the inflows and outflows, from this to that, from here to there, and everywhere in between. Many of them could be quietly rotating from bonds to equities and back to bonds again in small doses. Something has to account for those blue spikes in bond yields just prior to equity corrections, followed by the rise of bonds and the fall of stocks.
Some investors, at least, seem to be dabbling in both markets, making quick gains in the latter part of an equity run and storing it in bonds while waiting for the next correction… which could be closer than most realize if the death cross fulfills.
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