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December 14, 2010

Bearish Indicators

The bond market sent the Fed an acute message of disdain on the heels of today's FOMC meeting. The world's most powerful and malfeasant cabal reiterated a determination to complete a $600B bond purchase program, and the Treasury market responded by accelerating its plunge to a 7-month low. Interest rates are on the rise, and it seems only a matter of a short time before we receive confirmation that the quarter-century bear market in interest rates is history.

Long bond monthly chart of bull market

Likewise, municipal bonds are running into serious trouble.

Sell-off in municipal bonds

As any student of the markets knows, rising interest rates are typically bad for stock prices, and I have been anticipating for quite some time that falling bond prices would put an end to the cyclical bull market in stocks. So far, equities have been tenacious. However, despite the equity market's seemingly incorrigible rise, bearish signs abound in the form of significant divergences and overheated sentiment. For example, Sentimentrader's dumb money confidence indicator is now at a 6-year high. While previous instances of nosebleed sentiment readings have not necessarily lead into strong declines, they have all halted the market's advance. Likewise, put/call ratios are suggesting small traders are overly optimistic at this junture.

Despite a return to marginal new highs, fewer stocks are participating:

Bearish divergence in stock market indicator

Bearish divergence in stock market indicator

At this point, it would be quite dangerous to rely on seasonality to support stocks. The next weekly swing high will likely mark the beginning of an interim correction, and the outlook for a subsequent return to new highs will highly depend on the nature of the correction.

 

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