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Bond and Currency Markets Starting to Sound Off Bearishly in Unison -- Finally

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While equity markets have done little more than correct for a few days at a time up to this point, the signs from the currency and fixed income markets are starting to line up in favor of a consolidation / correction for stocks.

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It has not mattered much up to this point this year, but at some point (soon?), we may start to see the various asset classes return to their traditional relationships where weakness in bonds and currencies leads to corresponding weakness in equities. The weakness in the Aussie and Canadian dollars, for example, has clearly been matched by weakness in the commodities arena for months now. However, stocks have been immune to the virus in the other asset classes so far. Now that Ben Bernanke and the Fed have uttered some words that are less dovish than normal, perhaps we will get back to "normal" relationships across all asset classes.

Before I get into my usual fixed income and currency work, I wanted to touch briefly on some economic and market internal "stuff."

ECONOMY

Today's weekly jobless claims and the upward revision to last week's numbers have created two straight weeks of a rise in the 4-week moving average of claims. As you'll notice in the graph below (which shows the 4-week average of claims with the adjusted weekly closing value of the S&P 500 (INDEXSP:.INX)), the equity markets (red line) have generally risen as the average claims (blue line) have trended lower. Two weeks does not a trend make, but if the data continues to flow in like it has the last two weeks, we may see a period of consolidation (at best) for the equity markets. By the way, for those sticklers out there, my view is that the 4-week average of claims is a coincident indicator for the market and not a leading indicator – but it is clear that the market does not tend to do well when the blue line is trending higher.

TECHNICAL TELLS FOR THE EQUITY MARKET

Here's a quick observation on today's (Thursday's) action in the equity markets. I view today as being end-of-month window-dressing time and little more. The volume today is very light and is falling in line with the recent pattern of higher volume on down days and lower volume on up days. Notice that the volume on May 22 (a down day) still hasn't been eclipsed (over the last five sessions). Even the little upswing in volume on May 28 was accompanied by what I view as a distribution candlestick where prices closed out near the session's lows rather than the highs.



Now, onto bonds and currencies…

BONDS

Treasury yields have spiked and are overbought, but should have a bit more upside before this correction is over.

Much ado has been made about the rise in Treasury yields over the last couple of weeks. The rise has been sharp to be sure, but the fact that it is rising is to be expected technically. Unless and until the yield on the 10-year US Treasury Note ($TNX.X) breaks and closes above 2.284%, I view this rise as nothing more than the "c" wave of an "abc" upside correction. If 2.284% is broken on a closing basis, I will absolutely be singing a different tune, though.



Junk bonds reflecting the short-term bearish turn in attitude towards risk assets.

High-yield bonds are showing a little short-term weakness currently. In fact, if the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK) closes the month out below $40.75, it will be a bearish engulfing candle (a sign of more short-term weakness to come). Based on the chart below, I feel JNK can trade all the way down to around $39.50 without creating any long-term bearish technical signals. Such a pullback would almost certainly be accompanied by a further pullback in stock prices – although it doesn't have to by any means.



Emerging market bonds are breaking a long-term uptrend line, but may have some support below current levels.

The other key risk measure in the bond markets is the emerging markets debt sector, shown below by the iShares JPMorgan MSCI Emerging Markets ETF (NYSEARCA:EMB). Clearly, EMB has broken down below the long-term uptrend line – certainly reflective of the run away from emerging markets assets (just as we've seen in emerging markets equities via the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM)). The bulls can still hold out hope, however, that this is all merely a corrective move to the downside in EMB as long as $115.13 (the 100% Fibonacci price projection line for the potential "abc" downside correction) holds up as support. Any break and close below that level (especially on a weekly closing basis) will spell real trouble for EMB. Overall, we can clearly say that emerging markets debt is either foreshadowing weakness in risk assets (at worst) or is at least failing to confirm the upside we've seen in other risk assets so far (at best).


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No positions in stocks mentioned.

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