If there was any doubt that the bulls were in charge, Friday's payrolls should suffice. The S&P 500 has rallied for nine consecutive days reaching a new 2 1/2 year high on Friday. What started as a short-covering rally has turned into a full-blown bull market rally that should last for another four weeks or so, carrying the S&P 500 to 1245 before marking a lasting top. For bears that may have missed the equity rally, the best possible alternative is now in bonds.
Subscribers know that over the past six weeks we have felt like "The Boy Who Cried Wolf" on our bond market stance. Even as the market turned against us we stated unequivocally, "If bulls are going to rally the equity market, bonds should fall hard and fast. So we are holding our shorts." Our rational was that both US stocks and bonds were overvalued and one (if not both) of these markets was wrong.
As it would happen we covered our US equity shorts and went long the market back on October 26 (following the break above downtrend resistance in the S&P500). At this point we began to fear that the market would not fall hard ahead of the election, as we had initially forecasted. This was a strategic move on our part but not a capitulation. Our core position since late August and early September has been long Taiwan, Japan, and Australia. As a group these positions are up 17%, 2%, and 16% respectively since we first highlighted them for our subscribers.
Yet, to illustrate just how wrong we felt the bond market was we showed a graph of the CRB to Bond ratio and US interest rates. We said that not only had this ratio broken out of its 10-year channel resistance but that it was resting on support which now consisted of the same former resistance line and the 50% retracement of the decline from 1994 to 2001. Technically, this is hugely significant and should lead to more "reflation" in the coming weeks to months.
Moreover, the relationship between yields and the CRB to Bond ratio broke down severely in 2002 (blue box below) as Asian central bank intervention to support US treasuries via the dollar created a massive divergence in what is usually a close relationship. Looking at this chart we said that if the CRB to Bond ratio was trading above its decade long resistance line, the 10-year yield should be at or near the same relative level. As you can see, this would imply a 10-year note yield around 6%, well above the artifically low 4%.
Now that we believe US equity markets will rally into the New Year we are confident the bond market will get hit "hard and fast." On Friday we were paid our due with a key break of trendline support in the five, ten and thirty year bonds. If stocks rally to new multi-year highs, bond prices should at the very least retest their June lows. For bond bears this marks a prodigious opportunity.
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