Stock/Bond Ratio Turns, Gold Follows TLT Lower, Oil Hits Support with a Bang and the Dollar Remains Rangebound (Premium)

The stock market environment is bullish and we are seeing a rotation within the stock market. Yield spreads are edging up, but so is the Fed balance sheet. Elsewhere, we are seeing more risk appetite when looking at the stock/bond ratio. The recent breakdown in bonds appears to be negative for gold and gold remains in a long-term downtrend. Oil is making an attempt to reverse off a support zone. The bullet points below sum up the current market environment.

  • The S&P 500 SPDR (SPY) hit a new high this week and remains in a steady uptrend.
  • The Nasdaq 100 ETF (QQQ) hit a new high in early August and remains in an uptrend, but is quite overextended after a 15+ percent advance since mid May.
  • The S&P 500 EW ETF (RSP) broke out of a consolidation in early August and hit a new high this week.
  • The S&P MidCap 400 SPDR (MDY) broke out of a falling channel in early August and this breakout is holding.
  • The Russell 2000 ETF (IWM) remains range bound since March, but the swing within the range is up. Charts for the ETFs above were shown Thursday.
  • Stocks (SPY) are outperforming Treasuries (TLT) again, and Junk bonds (JNK) are outperforming Treasuries (TLT) (see commentary below).
  • The Composite Breadth Model has been bullish since May 2020 (see Market Regime page).
  • AAA and BBB yield spreads ticked up the last five weeks, but remain at low levels overall (see Market Regime page).
  • Junk bond and CCC spreads ticked up the last four weeks, but remain at low levels overall.
  • The Fed balance sheet expanded a little this past week and hit a new all time high.
  • The 10-yr Treasury yield broke out in early August and reversed its downtrend. It is also back above its rising 200-day SMA.
  • The 7-10 Yr Treasury Bond ETF (IEF) and 20+ Yr Treasury Bond ETF (TLT) turned down sharply on August 5th and broke their falling 200-day SMAs this week.
  • The Dollar is near the top of its 2021 trading range and the Euro is near the bottom of its range.
  • Gold plunged along with the 20+ Yr Treasury Bond ETF (TLT) and is positively correlated with Treasury bonds.
  • Seasonally, August and September are the weakest months of the year for the S&P 500, but price action remains strong for the index.
  • There is a rotation afoot as money moves into ETFs associated with the finance, industrials and materials sectors over the last few weeks.

Stock/Tbond and Junk/Tbond Ratios Turn Back Up

Two ratios related to the bond market turned back up over the last two weeks and this is positive for stocks. The first chart shows the performance of the Junk Bond ETF (JNK) relative to the 20+ Yr Treasury Bond ETF (TLT). Junk bonds represent the riskiest part of the bond market (risk-on) and TLT represents the safest end of the bond market (risk-off).

The JNK:TLT ratio rose (JNK outperformed) from late September to March (risk-on). This is also when the Russell 2000 ETF (IWM) and Regional Bank ETF (KRE) outperformed. The JNK:TLT ratio then fell and dipped below its 200-day SMA in July. Notice that IWM and KRE underperformed during this period. The ratio turned up the last two weeks, broke its mid July high and exceeded its 200-day SMA. We also saw a sharp upturn in KRE and a bounce in IWM this week. Looks like risk is back on for small-caps and banks.  

The next chart shows the SPY:TLT ratio, which measures the performance of stocks relative to Treasury bonds. Stocks are the classic risk-on asset that outperforms when the risk appetite is strong. Bonds are the classic risk-off asset that outperforms when investors seek safe havens. First, notice that this ratio broke down in late February 2020 as money moved into safe-haven Treasury bonds. The ratio bottomed in late March 2020 and moved higher into May 2021 as stocks outperformed Treasuries. The SPY:TLT ratio fell in June and July as ETFs related to the finance, industrials and materials sectors underperformed. We are now seeing this ratio turn back up and SPY is once again outperforming TLT. This should also bode well for ETFs related to the finance, industrials and materials sectors.

Treasury Bond ETFs Reverse after 50% Retracements

The next chart shows TLT falling over 20%, bottoming in March and advancing around 15%. The line chart (upper left) shows that this advance retraced half of the prior decline, which is normal for a counter-trend bounce. The candlestick chart (lower left) shows a support break with a sharp decline the last six days. I view this as a reversal of the upswing that began in March. More importantly, it looks like the longer term downtrend is reasserting itself.

The next chart shows the 7-10 Yr Treasury Bond ETF (IEF), the 10-yr Yield and the 10-yr Breakeven Inflation rate, which measures inflation expectations. Bonds loathe inflation and the recent breakout in the 10-yr Breakeven Inflation rate bodes ill for IEF and TLT. The middle window shows the 10-yr yield breaking above its mid July highs this week and exceeding its rising 200-day SMA. This argues for an uptrend in Treasury yields and a downtrend for Treasury bonds.

Gold is Positively Correlated with TLT

Now let’s hit gold. First note that I do not have a great handle on gold. Price action has been quite choppy and there is more downtrend than uptrend since September 2020. The green shading shows when RSI(14) moves below 31, which means GLD is quite oversold. Prior readings gave way to a bounce, but not always right away (see blue arrows).

Also note that gold is negatively correlated to Treasury yields and positively correlated to Treasury bonds. This means the breakout in the 10-yr yield and breakdown in TLT are negative for gold. The bottom window shows the 65-day Correlation between GLD and TLT, based on price changes. There is clearly a positive correlation over the last two years, which means they tend to move in the same direction. Thus, further weakness in TLT would be negative for GLD.

Dollar Rise to Top of Trading Range

The next chart shows the Dollar Bullish ETF (UUP) popping above its 200-day SMA in June and then chopping around just below the April high. The greenback has gone nowhere this year with a big trading range (blue lines). The Euro ETF (FXE) is trading near the bottom of its range and the Yen ETF (FXY) is in a clear downtrend. The red lines on these charts mark resistance and upside breakouts would be negative for the Dollar. The July low and 200-day mark support for the Dollar and a break here would be negative.

Oil Attempts Reversal at Support

Oil remains in an uptrend overall and is currently testing a support zone. The chart below shows a rising channel and broken resistance turning support in the 65-68 area. Oil fell to this zone in July and again in early August. RSI also dipped into the oversold zone twice. Thus, a mean-reversion setup remains in play and we are seeing signs of a short-term reversal on the USO candlestick chart (lower left). Notice the plunge, hammer and surge. There are gaps, but USO is just reacting to trading that already occurred in the futures market. The line marks resistance and a breakout here would be bullish. Click here for current prices at the CME.  

Thanks for tuning in and have a great weekend!

-Arthur Hill, CMT
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