|It doesn't take a secret agent to uncover clues to money flow between two pillars of capital flow: equity and security markets. Traders have known for some time that stocks/bonds behave in a reverse relationship: stocks rally when investors feel bullish and bonds rally when investors feel cautious.|
|Numerous market pundits have lauded how bonds are a poor place for capital now that the economy is "sure to recover" sometime this year. The argument goes that bonds (or cash) offer little if any return compared to stocks. While that may be true on the upside, few investors have forgotten that equity markets can indeed offer negative returns for a year. No matter how poor cash or bonds may perform, it's pretty tough for them to expose investors to the downside risk that equities naturally endure.|
|Figure 1: 60-Min Chart: FYX|
|Graphic provided by: Quote.com.|
|Graphic provided by: QCharts.|
|Bond yields rose on the New Year's euphoric pop as stocks rallied and bonds sold off. Did anyone expect equity markets to soar into new all-time highs? Hardly, but if they did a first warning that such would not happen was the double-top reversal of bond yields and drop below the 50-period moving average (light green) on Monday the 7th. Yields fell as money flowed into bonds. Where was it flowing OUT of? You guessed it... equities!|
Figure 2: 60-Min Chart: Dow Industrial Average
Bond markets open and close one hour earlier than stocks. Early buying in bonds dropped the yield and gave savvy traders who monitor bond pricing an indication that stocks would come under pressure from there. A continued fall in yields may have kept traders short broad equity markets on the winning side all week. One of the most powerful trade filters for short-term traders to monitor is certainly bond yields, specifically the 13-week, two, five and ten year notes.
Bonds also offer trading opportunities with relatively new option products listed on the CBOE. We shouldn't be surprised if some type of tracking share instruments become available soon as well, offering alternatives for trading bond instruments in the futures market.
In any event this somewhat inverse relationship between equity and security markets remains an important trade filter for us to watch when money ebbs & flows between the two.
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