Tuesday, May 27, 2014

Keystone's 2-10 Yield Spread Indicator

The last look at the 2-10 spread was in January as the spread was teasing the critical 255 level. Traders began the year believing that financials would lead higher but so far that is not the case. Keystone uses a 255 spread as the signal line distinguishing happy banks from sad banks. The higher spread (above 255) reflects a steeper yield curve and big profits for banks. If the spread stays under 255, it shows an ongoing banking malaise and nothing to become excited about concerning trading banks from the long side.

Higher Treasury yields typically result in the interest-rate sensitive stocks such as utilities, telecom and home builders selling off while banks run higher salivating over a steeper yield curve. The 2-year Treasury note yield is 0.35% and the 10-year note yield is 2.53% resulting in a 218 basis-point 2-10 yield spread. The spread increased into the 260's at the end of last year and the banks appeared golden destined for greatness. That thinking ended the first day of the year as the 10-year yield peaked out at 3% and has collapsed. TNX has dropped from over 3% to under 2.5%, 50 basis points, in only four months time. As long as the spread remains sub 255, banks and financial stocks should remain challenged.

The 2-10 spread chart above shows the positive divergence and inverted H&S (green lines) pointing the way to the top in the 260's. Then the double-top with negative divergence (red liens) creating the spank down. Stochastics are setting up with positive divergence right now and are oversold. The histogram is positively diverged, but the RSI trends weaker in bear territory under 50%, and has not reached oversold territory as yet, and the MACD line is weak and bleak wanting to see further lows. Thus, a sideways malaise may be on tap for the 2-10 spread drifting lower to test the 200-day MA at 205 basis points in the weeks ahead. A range of 200-240 is a reasonable expectation which would keep the 10-year yield below 3% for many months forward, even a year or perhaps three. If the 2-year yield remains anchored around 0.35%-0.40%, with a 200-240 spread range, this places the 10-year yield at 2.35%-2.80% for the weeks and months ahead.

At the stock market bottom in March-April 2009, the 2-10 spread was about 200 signaling the ongoing turmoil and trouble with banks. In December 2009, the spread was up to 288 with drunken banksters toasting Chairman Bernanke's QE policies as the yield curve steepened and the wine flowed like water. The spread was 270+ into summer 2010 when another deflationary scare occurs dropping the spread under 255. Chairman Bernanke saves the equity markets with QE 2 in August 2010. In early 2011, the spread is back above 255 favoring the bankers but then in the summer of 2011 the spread falls under 255 and remains under until briefly sneaking above in December 2013. As the chart above shows, the move above the critical 255, to begin the year, could not be sustained.

During last year, the 10-year yield spiked higher and everyone thought the happy banking times were here to stay, and, as typically occurs in markets when everyone is on one side of the boat (higher rates and higher bank stocks), this is where the yields reversed, dropping the spread from above 255 to below 220.

The XLF (financials sector ETF) and KRE (regional banks) peaked in March. The coming weeks will tell if this is a multi-month and multi-year top for bank stocks, or not. The XLF will likely move higher if the 10-year yield creeps higher and sends the 2-10 spread higher. Watch the 255+ spread to see if the steepening yield curve occurs, or not. It is very hard to envision bank stocks moving higher with the yield curves flattening or remaining benign. Especially with more regulations on the investment and trading side the banks need a steeper yield curve to help generate profits on the traditional banking side.

Keystone's current projection is continued sideways and sideways lower price action for the financials ahead with the 2-10 spread remaining under the 255 mark. A period of disinflation and perhaps deflation continues to be a possibility for the next year or two, although Keystone is lonely in this camp; one of the very few Wall Street analysts with this view. Keystone is one of the extremely few analysts, rare as hen teeth, that predicted the drop in the 10-year yields this year (type '2013 Predictions' into the search box at the right to review Keystone's forecast).

The inflation, and perhaps hyperinflation moves, in the markets and economy, which must occur due to the Fed's obscene money printing scheme for over five years, are likely months and years away still yet. The 18-year stock cycle remains in a secular bear until 2018. Therefore, long stock holders are not prepared for a multi-month and multi-year cyclical bear market to finish the secular bear 18-year cycle in 2016-2019. Even if this important 18-year cycle is left-translated this time around, that would be 2016-ish as the bottom for the secular bear in stocks which may indicate a sick period of disinflation and deflation with flat rates continuing for the next 1 to 3 years, at a minimum, perhaps low rates for 4 or 5 years, at a maximum. Inflation, however, will be raging in the late 20-teens and 2020 and beyond. Watch the 255 number for the 2-10 spread to gauge if the banks are happy, or sad. A prolonged period of low 2-10 spreads should weaken the banks. Watch XLF (now trying to maintain the 22 level), $BKX, KRE, JPM, GS, BAC, C, MS, and all the other clowns.

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