3 Troublesome Signs for the Market

by Anthony Mirhaydari | May 29, 2014 5:46 am

3 Troublesome Signs for the Market

If you look at the S&P 500, it’s still all good. Volatility is nil. New records are being bagged each day. It looks like we’re on the path to economic deliverance.

Maybe. But the good feelings aren’t shared everywhere. In fact, the world’s largest and most important market — the market for U.S. Treasury bonds — is warning of serious trouble despite the stock market’s euphoria. Long-term bonds are rallying hard, in an apparent bid for safe-haven assets by fixed-income traders.

But it’s not just bond investors that are nervous. Here’s a closer look at the debt issue, as well as a couple other areas that are flashing warning signals.

Bonds

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The bid for long-term Treasury bonds is helping push down the yield on the 10-year note from a high of more than 3% in December to just 2.4% now. That’s below the range of 2.6% to 2.8% that’s prevailed for most of 2014 so far.

Lower interest rates sound like a good thing, especially with the housing market in need of a kick in the rear. The problem is traditionally, a drop in long-term interest rates is associated with economic or geopolitical troubles.

This is especially true given that the Federal Reserve is in the midst of scaling back its long-term bond purchase stimulus — which is on track to end completely around October.

In fact, the disconnect between yields and stock prices has widened to an extent that was seen in the middle of 2011 ahead of a harrowing market plunge related to the loss of America’s AAA credit rating.

It’s not a slam dunk: Stocks ignored a drop in yields around this time last year.

But it’s something to be mindful of.

Currencies

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Another proxy for risk appetites in the market comes from the relationship between the euro and the Japanese yen.

The so-called euro-yen cross exchange rate is so important because hedge funds and other institutional traders use the “yen carry trade” pair to raise capital for speculation. They short the yen and go long the euro.

It’s such a popular trade that oftentimes the S&P 500 will closely mimic, tick-for-tick, the vagaries of the euro-yen exchange rate.

The problem is right now the euro-yen rate is warning that something is amiss. In fact, if the relationship between stocks and the euro-yen carry trade were restored (they’ve diverged so far this month), stocks would be down and testing their January lows, not pushing to record highs.

That would be worth a 5% decline from current levels.

Commodities

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And finally, it’s worth mentioning that the raw materials of industry aren’t jibing with what stocks are doing this week.

The DB Commodities Tracking Index Fund (DBC[1]) rallied in unison with stocks back in February and again in April, but is failing to participate this time. Perhaps a spate of disappointing economic data at home and overseas is capping enthusiasm in the commodities pits. Just look at Wednesday’s report on German unemployment, for instance: the first increase in six months.

The DBC is back testing its 50-day moving average. If the S&P 500 were to follow, it would need to reverse all the gains of the past week.

If you view the “market” as a collection of individual marketplaces — rather than just looking at what stocks are doing — you get a decidedly less euphoric picture.

Anthony Mirhaydari is founder of the Edge[2] and Edge Pro[3] investment advisory newsletters, as well as Mirhaydari Capital Management[4], a registered investment advisory firm.

Endnotes:
  1. DBC: http://studio-5.financialcontent.com/investplace/quote?Symbol=DBC
  2. Edge: http://www.edgeletter.com/
  3. Edge Pro: http://www.edgeletterpro.com/
  4. Mirhaydari Capital Management: http://www.mirhaydaricapital.com/

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