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Relationships Work Until They Don't



Over recent weeks, there has been a lot of commentary in the financial media regarding the dollar, bond and stock relationship. Here's my take: First, the historical correlation isn't as high as most would think. Like anything else there are periods of time where the three financial instruments move in unison and as a result, the relationship is seized upon by the financial press and others as being the magic bean. As you know, the magic bean doesn't exist and eventually, the dollar, bond yields and stocks will decouple and the next hunt for the latest and greatest indicator will be found. But until that is the case, market participants will use it until it stops working.

So far the relationship continues to show signs of working. When the dollar began to slide and eventually broke the lower end of the range, many thought the markets were decoupling because it seemed like a no-brainer that once the war was over, everyone would raid their bank account and spend every last cent available making bond yields go up. Obviously the consensus was wrong about spending (so far) and bond yields, which are rapidly moving to the lower end of the range. Stocks have yet to move to the lower end of the range so the next question is whether stocks should follow suit?

I am not sure if stocks should or shouldn't, but I do know that it provides a real excuse for taking profits in an intermediate-term overbought market. The decision on whether stocks are going to tank or not don't necessarily need to be made right this instant. In a media-driven market, there is a constant press to say, "up big" or "down big" and much like life - it isn't that black and white. There is enough momentum to suggest normal profit taking market wide would be healthy and temporary. There are also signs that the intermediate-term rally is long in the tooth and that some rotation is likely to take place.

The U.S. Dollar Index continues to get blasted

Source: Baseline

The 10-year note yield apparently is following along - again.

Source: Baseline

So far, stocks have been left out of the "pity party."

Source: Baseline
More on the BKX

As you know, I have recently focused on the PHLX Bank Stock Index (BKX) and that the current level of intermediate-term overbought typically leads to a sharp pullback. Some level of that pause came yesterday with a 2% decline. That got me thinking to do an overlay of the BKX and the 10-year Treasury bond yield. What I found confirmed to me that the correction should take a little longer and may go a bit deeper than a 2% one-day loss. As you can see from the chart below, the two have moved in the same direction over the last year - until now where there is a very significant divergence. I don't know how the divergence is going to be resolved, but a sharp decline in bond prices (incr. In yield), a sharp decline in the BKX or a combination of both argues that adding new money to the financials here may not make a lot of near-term sense.

The BKX and 10-year Note yield agree that Financials are due for rest.

Source: Baseline

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No positions in stocks mentioned.
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