Stocks Down Bonds Up | Stock Market Investing

Sunday, June 22, 2008 | Home | Andy Mayo

There is gloom and doom in the stock market, perhaps best exemplified by a chart from Smith Barney that shows an ominous similarity to the Dow Jones Industrial Average in 1938 to its position in 2008. 

And if we look at the NYSE New Highs minus New Lows index, we can see a serious red flag waving:  The long-term moving average, which has not been above the zero line since last November, and has now crossed below its short-term moving average.  The last six times this happened, falling stock prices followed.  The chart is here.

And the darling of the Bull Market -- emerging market stocks -- are also in a precarious position.  The exchange-traded fund EEM closed Friday at 137.20   Support is at 134.  Not much margin for safety.

On the positive side, the relative strength of small cap stocks to mega-caps has turned decisively positive.  Small cap stocks typically lead the economy out of a recession.  And while the exchange-traded fund IWM, which tracks the Russell 2000, is still below its 50-week moving average, it is in considerably better shape that the exchange-traded fund OEF, which tracks the 100 largest companies in the S&P500.  This chart tells the story.

Then of course, there is the possibility that oil really is in a bubble formation.  As we see here (I wont make you click over to Newsletter) first it was the dot-com bubble, then it was the real estate bubble and now oil has reached the same fulsome level.  A popping of the oil bubble (if that is indeed what it is) would be a boon to stocks.


(Another reason to consider the possibility of falling commodity prices is regulation.  Two new bills have been introduced in Congress and the anti-speculation drumbeat is clearly being sounded in the media.

"Close the London Loophole Act" which would require the Commodity Futures Trading Commission (CFTC) to impose speculative limits and reporting requirements on traders of US energy commodities using a foreign exchange; "Policing US Oil Commodities Markets Act of 2008" would require trading of all US commodities on domestic terminals for US delivery to register and be regulated by the CFTC.)

Finally, there are bonds.  This chart is quite cluttered but here are the main points:

Bond prices peaked at the March low-point for stock prices.  They fell steadily until last week.

Bond yields and stock prices moved up in lockstep from the March lows to the second week of June, when stock prices began to fall while bond yields continued to rise (and consequently bond prices continued to fall).

Bond yields are now at a decisive support trendline.  A drop in yields in the coming week should spur bond prices and such a drop could occur regardless of inflation concerns -- when investors bail out of stocks and buy bonds, bond prices go up and yields go down.

Why would they switch now?  The relative strength of the 20-year bond (exchange-traded fund TLT) to the S&P 500 has rallied, surpassing its 50-week moving average, also last week.  So it seems probable that stock prices will continue to fall and bond prices will rally, at least in the near-term (barring, of course, the popping of that so-called oil bubble).  Charts courtesy of StockCharts.com.

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