Monday, October 14, 2013

10-Year UST Note Has Dandruff

In a blog post last week, I discussed the relationship between interest rates and the stock market, namely that over the last several years the relationship has tended to be positive. As yields on UST bonds have risen, so too have equity prices, and vice versa. 

With the following weekly chart of the 10-year UST note, I wanted to further explore this topic.

It appears as if the 10-year UST is experiencing a case of dandruff as a bearish head-and-shoulders formation is plainly evident (blue circles). The neckline looks to be a bit upward sloping (orange line), which is not a more classic horizontally-drawn line but also not a nullifier of the pattern. Nonetheless, a case can be made for a horizontal neckline at about $127 (red line) -- in either case, both necklines have been breached to the downside. More recently, the multi-year ascending trend line (red) has likewise been broken to the downside as the UST fell below $125. The 10-year has since undergone an anemic, reflex-rally back to the horizontal neckline and looks to be rolling over as the $127 neckline level now serves as overhead resistance. This snap-back price retracement after a neckline breach is a fairly common occurrence and more often than not sets up for a follow-through move to the downside in response to the neckline holding firmly as resistance.

Assuming the UST does indeed suffer another leg down, it would be bullish for equities, at least based on past history. In the chart above, I show respective S&P 500 levels (purple numbers) at key turning points for the 10-year UST note. Since late 2008, a downward-trending UST -- and therefore upward-trending yield -- has generally seen the S&P 500 appreciate in that time (and vice versa).

Needless to say, $127 has become a key level for the 10-year note, something to monitor closely. I do expect the neckline to hold and for the UST to roll over, however if the 10-year climbs through $127 meaningfully (beyond $128), it would require prompt reassessment with equities likely feeling the brunt of it.

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