This market is on fire, even with news out the the Fed intends on ending QE soon. Better than expected data on economic growth fueled today’s blastoff. The Dow Industrials closed up 221 points at 17,195.42, while the S&P 500 Index gained .62%. The Nasdaq Composite lagged, rising “only” .37%. What I did not like despite today’s great upside action is that Treasury bond yields closed lower.
Long and strong was the watchword for today. ERUS, a Russia Index ETF, rose 4.83% albeit on below-average volume. EWZ, the Brazil Index ETF, gained 4.01%. JDST, the 3x leveraged junior gold miners Bear ETF, shot up a staggering 26.23%. ZSL, the leveraged short silver ETF, jumped 6.65%. Please click on the symbols for details.
There is usually a strong correlation between interest rates and equities. A rising market is usually met with rising interest rates. On one level, it’s simple supply and demand. When rates are too low, the historic risk-adjusted return for equities is greater than it is for bonds, so money shifts to equities. Equities therefore rise over time as institutions allocate more money to equities compared to bonds. When existing bond positions are sold so the proceeds may be repositioned into equities, there are more bond sellers than bond buyers. To attract bond buyers, yields need to be higher, ergo, lower bond prices (prices and yields are inversely correlated with each other).
Usually, there is a positive correlation between stock prices and interest rate yields. A positive correlation indicates that two assets tend to move in the same direction. A negative correlation indicates a strong tendency for two assets to move in opposite directions. A correlation value of near zero indicates there is very little correlation between the two assets. The highest positive correlation is 1.0 and the lowest negative (inverse) correlation is -1.0.
The intermediate-term correlation between treasury bond yields and the S&P 500 Index is usually strongly positive. But lately that correlation has weakened and today bond yields were down even though the stock index was sharply higher. I expected yields to be higher as well but that wasn’t the case. In the daily chart below the 30-year treasury bond yield ($TYX) is charted on top followed by SPY below that and the correlation between the two on the bottom of the chart:
In the next day or two either yields should continue higher or equities turn lower…should being the operative word. Just because something should be doesn’t mean it will be. I guess the answer to that is something we will know, in the fullness of time.