Bonds sink - stocks rally? Hang on a moment...

An extreme difference between the percentage change in bonds and equities could signal the end of a bear market rally?

Photo by Hans-Jurgen Mager on Unsplash

Many technical indicators point to an oversold condition, which could favor a rebound from a purely technical perspective. However, we should also keep an eye on cyclical patterns, especially as what worked in a bull market does not necessarily have to work in a bear market.

Since the general change in the market structure from "bull" to "bear" from December 2021, we have a recurring pattern that has signaled the end of the bear market rally.

First, let's explain the pattern:

Bonds and stocks move "in tandem" over the current market context. Higher yields cause bonds and stocks to decline. What's interesting is the timing of when the equity markets try to decouple from the bond market. That is, stocks begin to rise, but bonds do not. These situations are indicated by the numbers 1 through 4 in the chart below. The chart shows 20-year Treasury bonds ( TLT 0.00 ) and the S&P 500 ($SPX) Index.

Notice that every time stocks started to rise and bonds did not, this is just a phase that will have to be resolved soon. Then, in almost all cases, the bear market rally ends.

TLT vs. S&P500 percentage changes (daily) | 22. Oct. 2022 (Chart: TradingView)

So the question is, how large does the divergence have to be to stop the stock market rally?

Let's apply the above observation to a cyclical oscillator. We calculate the difference between the change in the price of stocks and the change in the price of bonds. If stocks and bonds move "in sync", that difference will be zero. If stocks move up and bonds move down, we' ll see high values of this indicator.

I like to call the cyclical difference indicator between stock and bond changes "The Springboard." The following chart will tell why:

With the introduction of the cyclically smoothed version with dynamic bands, this oscillator now helps to identify extreme differences between the behavior of price changes in bonds and stocks. On this chart, I have highlighted when the extreme swings occurred above the cyclically smoothed bands with red arrows.

This indicator signaled the end of all bear market rallies so far. So let's see - we just have another extreme reading!

We will see what happens - I justed wanted to get this picture out to you before the fact. Monitoring Yields and Bond rates are very important during these times.

Have a nice week.

Regards,
Lars

---

Disclaimer:

The publisher does not warrant the accuracy or completeness of the information provided on this site. All statements and statements contained herein are the sole opinion of the author.

Lars von Thienen / WhenToTrade is a publisher of scientific cycle analysis results for global markets and is not an investment advisor. We do not provide personalized or individualized investment advice or information tailored to the needs of any particular recipient.

No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.  

Any projections, market outlooks or estimates herein are forward looking statements and are inherently unreliable.  They are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.

Neither the publisher, the author nor any of its affiliates accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein.