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Bond Model Turns Positive

Our fundamental bond model has turned positive, and we are bullish on US Treasury bonds.

Since 2010, strength in the bond market (and in our model) has been a precursor of economic weakness and signaled an intermediate term top in the equity markets. Figure 1 shows a weekly price chart of the SP500 with an analogue version of our bond model in the lower panel. At point #1 the bond model turned positive in March, 2010. Shortly thereafter the market had its spring and summer swoon on concerns for economic weakness. The Federal Reserve came to the rescue with QE2, which was telegraphed by Federal Reserve Chairman Bernanke at the Jackson Hole meetings. Point #2 is March, 2011 and once again economic concerns began to surface. The equity market essentially went into a 5 month topping process that led to a 20% drop over 5 weeks in August, 2011. Our recession based model actually indicated that the US economy was in recession, but the Fed intervened with Operation Twist putting a floor under the economy and the equity markets. Point #3 is the April, 2012 top that once again led to a market swoon, which wasn't as violent as the year before primarily owing to the fact that investors had been conditioned to buy the dip on the belief that the Fed would come to the rescue. Of course, these investors were rewarded for front running the Fed as this eventually led to the announcement of QE3.

Figure 1. SP500 v. Bond Model/ weekly
SP500 v. Bond Model - Weekly

So now we have another signal in the bond model presumably suggesting economic weakness and equity market weakness. Why else would the bond model be bullish at such ridiculously low yields? This is the safe haven play. However, with the Fed already "all in" (remember this is QE to infinity) equity investors may be in for a bumpy ride. Is this the death of the Bernanke put?

 

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