Monday, February 26, 2018

Stock and Bond Correlation

Stocks are being dragged around by the bond market.  This is not a common situation, and usually doesn't last long.  The stock and bond markets have had a slight negative correlation since 2008, but before then, were often positively correlated.  Usually, stocks and bonds have had this kind of tight correlation when investors are fearful of higher interest rates, which bleeds over from fixed income into equities.

The inane belief that stocks will do fine even if 10 year yields go up to 3.5% or even 4%, is based on a market where stocks were priced at about half of current valuations (2010-2011).  No, when your stocks are at nosebleed valuations with so much corporate leverage, stocks will not be fine if the 10 year goes back to 3.5%.

It seems like last week's Fed minutes was the scare of the week, as the close on Wednesday marked the bottom of the move.  Its been a grind higher since, helped along by 10 year yields finally finding a bottom at 2.95% and moving lower since.

We have reached what I viewed originally as a good shorting zone of 2760.  But I am afraid that Powell will be more dovish than people expect tomorrow and that could put in a last gasp rally up to 2780.  I will consider putting on shorts at that level.  With the current worry about higher interest rates mostly priced in, stocks don't have much downside from current levels, perhaps down to 2640 at the worst, but more likely 2680.  So the general range now should be between 2640-2780, in a bearish scenario, or a more bullish scenario, 2680-2800.

So it is back to the 2017 approach to trading ES:  Only shorting absolutely perfect setups as investors get too optimistic or just buying dips on momentary scares.  Can't rush it on the short side just yet, unless bonds seem like they have made a short term top.

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