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State Of The Market: Credit vs. Equity

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    January 8, 2012

    Countless times I have discussed the credit event and the divergence between a multitude of credit products and the equity markets. Today I want to zoom in to one specific credit product the 10 year treasury futures and show just how interrelated it is with the equity market. How studying the moves within treasury will simply help you understand the larger moves within equity.

    In fact you can put all of the equity moves since the May 2011 highs in relatively decent perspective simply by comparing it to the treasury futures.

    July 2011 Equity Selloff Treasury Breakout

    In late July equity began a rather large waterfall decline. Personally I have tried to understand what was the cause. Was it the downgrade of US debt? Was it the break of the head and shoulder’s neckline? Nothing really stood out until I looked at 10 year treasury futures.

    What I found interesting was prior to the move in equity the 10 year futures had been consolidating in a bull flag pattern. Once the pattern resolved higher treasury futures move to new all time highs. This happened prior to the failed neckline in the equity head and shoulder pattern. It was also prior to the downgrade by S&P. It basically gave an early warning sign to a pending equity selloff.

    August 2011 through Present

    After breaking to all time highs, 10 year futures began a multi month consolidation process. Notice the 10 year treasury future consolidating above prior all time highs for nearly six months and in a bull flag pattern.

    Meanwhile equities have been moving within an ascending wedge, a bearish pattern. This simple chart puts the entire past six month move in equities in perspective. The 10 year has simply consolidated after a big move in August 2011. While it consolidates ahead of another big move equities have been able to trade within a relatively large range while trending higher.

    In other words there was no major shift in capital flow into treasury during this consolidation process leaving equity for the most part able to catch a bid.

    10 Year Treasury Future Technical Analysis

    The six month consolidation process is close to being resolved one way or the other. For now it appears the bull flag has failed and broken higher. Support has been tested multiple times and has performed well. Basically all holders of 10 year futures are profitable at this point so the selling pressure or overhead resistance is simply not present.

    What is also telling about treasury futures is the entire curve from two year to thirty year is in a similar pattern so there is breadth to this bullish move. 10 year is not trying to move higher on its own. Even in the face of the Fed’s Operation Twist and Foreign selling of US debt treasury remains above prior highs.

    10 Year Treasury Futures VS USD

    Another factor with the strength in 10 year futures is that of the USD. Below is a chart that shows the direct correlation between both. Although out of phase at times the similar trend is clear. With the USD breaking to a 52 week high in rather rapid fashion recently it will help fuel further treasury buying.

    10 Year Treasury VS SPX

    As for how powerful a treasury breakout can be simply look at the following chart comparing 10 year yield to the SPX. In July when 10 year futures broke to new highs (lower yield), equity converged and rapidly filled this divergence.

    Today the divergence is far wider than just six months ago. So while 10 year futures have spent 6 months consolidating equity has once again built a rather large divergence that will be resolved either with equity moving lower or treasury yield moving higher.

    Bottom Line

    What is telling above these two moves between equity and credit is the breadth or overall strength within each asset class. The treasuries are showing similar all time high price breakouts across the entire curve from the two year through the thirty year. So it is a breakout across the entire asset class.

    Within equities though as discussed on countless posts mid and small caps are not performing relative to the indices such as the SPX or Dow. The best analogy I can give would be the space shuttle launch. The solid rocket boosters as represented by the high beta mid and small caps launches the shuttle into high altitude. Eventually fuel runs out, the solid rocket boosters separate and it leaves the shuttle to finish the flight before it too runs out of fuel.

    We are close to resolution of the 10 year futures right now. The 30 year showed a lot of strength the past few days at support reversing off the lows intraday. The five year similar to the 10 year is extremely close to a breakout as well. Watch the treasury futures in the coming day(s).

    Images: Flickr (licence attribution)

    About the Author

    Macro Story is designed as a one stop source for all of your macro related news and data.  From credit markets to economic data to geopolitics, you will find it all in a simple and organized fashion.  Content is presented in a format that allows you to read as little or as much as prefered.  Whether your goal is to do advanced research, a simple market overview or to become educated on macro subjects, the site has been designed with you in mind.


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