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Indicator at 0.2% Offers Clues to Direction of Bonds, Stocks and Commodities

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If the data tells you to sell bonds, where should the money go?

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The Wall Street Journal noted the U.S. government sold the 10-year Treasury notes on Tuesday at the second lowest yield ever and the three-year auction on Monday attracted the strong bid-to-cover ratio since 1990. These extreme readings are reminiscent of the commodity froth in the spring. Are bonds the next overvalued asset class destined to go south?

Alchemyoftrading.com recently posted a weekly chart of the yield of the 30-year bond and its 52 week rate of change (ROC) from 1983 to last week. The chart made it clear that when the ROC reached low levels in the past, yields have gone higher. While the original chart focused on the indicator's predictive value towards bonds, let's see if there is any correlation to stocks and commodities as well.

We will change the chart slightly from weekly to a daily with a 252 day (i.e. still one year) rate of change and go all the way back to February 1977 when the 30-year bond was re-introduced. Because the indicator is a 1-year rate of change, it really starts in February 1978. It also must be noted that no new 30-year bonds were issued from February 14, 2002 to February 8, 2006 because the government was trying to pay off its debts. This plan did not quite work out as expected. So, in early 2006 the 30-year bond was re-introduced. Therefore, in 2002-2006 the rates in the chart aren't quite for 30-year bonds as the time to maturity slowly decreased by a few years. But it is a reasonable proxy of the long bond yield and good enough for our purposes. Anyway, let's add stocks and commodities to the mix and see what the chart looks like:


Click to enlarge

The top section is the 252 day ROC of the 30-year bond.
The second section is the 30-year bond yield.
The third section is the S&P 500.
The bottom section is the Continuous Commodities Index.

On Wednesday, December 14 the indicator closed at -36.7%. This means that the interest rate on the 30-Year bond was 36.7% below what it was a year ago. This has only happened on 20 prior days out of 8,458 trading days. That equates to the 0.2% percentile. At the top chart there is a horizontal blue line drawn at -36.7%. You can see that the 20 days where the indicator was even more extreme were congregated in two areas. These are highlighted by two vertical blue lines. One group had nine assorted dates from March 31, 1986 to April 18, 1986. The other group consisted of all 11 trading days from December 16 to December 31, 2008. Let's look at the first date from each group and see what happened next. All returns listed below use first date as the denominator.

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No positions in stocks mentioned.
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