Research Excerpts

The Bond Market Saw This US Stock Market Decline Coming

Posted on: Sunday, May 20th, 2012

In our April 24th blog posting, entitled A Flattening US Yield Curve & Upcoming US Stock Market Direction, we highlighted a brief excerpt from our April 24th Keys To This Week report (access requires subscription) which pointed out the recent flattening in the US yield curve and its negative implications for upcoming US stock market direction.

From that April 24th blog posting:

“This recent sharp reversal in the 2s/10s curve, which has narrowed to 170 bps through the end of last week, suggests that the forward looking bond market is now starting to price in a weakening US economy in Q2/Q3 2012.  Chart 3 points out that a flattening yield curve led US stock market peaks in April 2010 and May 2011.”

Almost a month later, the chart below shows that the US 2-year/10-year yield curve has continued to flatten, by an additional 31 bps to 139 bps through the end of last week.  Meanwhile the S&P 500 — which represents an indirect bet by investors on the direction of the US economy — has coincidentally declined as expected, by an additional 80 points or 6% into Friday’s 1292 intraday low.

Stock market investors are often near term oriented, basing their collective opinion on the next piece of market news or economic data.   Conversely, the bond market  is typically more forward looking, tending to look out over the upcoming quarter and often getting in front of the direction of the US economy, and in front of the US stock market that tries to chase it.

(We recently discussed this dynamic between the US stock and bond markets in our April 17th blog posting, entitled Race Horses, Meerkats, & Stock Market Direction.)

Accordingly, the US yield curve is one of several key market factors that we are monitoring very closely right now, to determine if the current April decline in the US stock market is just a correction within the larger October 2011 advance or the beginning of a more sustainable decline.

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