Source: Short Side of Long
One of the first observations I would like put forward is an interesting development within the US equity sector space. The relative performance of Consumer Discretionary (cyclical sector) against the Consumer Staples (defensive sector) has been weakening as of late. Previous instances where such weakness took place has been seen near intermediate market peaks, such as middle of 2007 and 2011. Other late cyclicals and defensive sectors, such as Energy and Utilities, have also been outperforming cyclicals such as Technology. This shows that investors have been moving more towards defensive names as of late, and could be a warning signal that the rally is now in its last stages.
Stock vs Bond ratio is giving us a bearish non-confirmation!
Source: Short Side of Long
Another interesting observation is the fact that US Treasury Bonds have started outperforming US equities once again. This too, also highlights the recent defensive nature investors are taking. The chart above does a great job showing S&P 500 against S&P 500 vs Treasury Long Bond ratio.
This ratio has been doing a pretty good job warning investors of potential negative surprises in economy and the stock market, whereby bond investor tend to react and discount up-and-coming negative news before their equity counterparts.
At that point, even though S&P 500 continues its march higher for awhile longer, the S&P vs Long Bond ratio starts creating a bearish divergence by actually moving downward. This indicator has correctly forecasted an equity market peak in 2000, 2007, 2011 and could be once again signalling a similar outcome today.
In my opinion, and from a contrarian perspective, Treasuries have many reasons to rally and might just outperform their US equity counter parts into the end of 2014.
Treasuries have done poorly over the last year & could rebound!
Source: Short Side of Long
First of all, a recent Bloomberg survey showed that EVERY single economist is currently forecasting higher interest rates (lower bond prices). When everyone thinks the same way, usually that is a sign no one is doing any thinking… and majority of the time something completely different occurs.
Second of all, Treasuries have gone through a terrible performance over the last two years and are extremely oversold on an annualised rolling basis, as seen in the chart above. This technical signal has had a good track record of picking intermediate lows in the bond market over the last couple of decades and could be showing us once again that the current rebound in Treasuries might continue for awhile longer.
A rise in the bond market, and simultaneous outperformance of defensive sectors, could be telling us that the economy is slowing, and/or earnings disappointments lay directly ahead, and/or last years superb stock market return could be in for a mean reversion.