Sunday, January 7, 2018

YC2YR Yield Curve Weekly Chart; 2-10 Yield Spread; Oversold; Falling Wedge; Positive Divergence

Nowadays you hear talking heads parroting the same jargon concerning the relationship between the inverted yield curve and the stock market. Here is how the schtick goes. Strategists proclaim that the stock market will not top out and sell off until after the yield curve inverts. The universal consensus also declares that a recession will not occur for at least a year or two more since the yield curve is not inverted and stocks will not turn over until the yield curve inverts and sentiment becomes negative. So it is all Fed wine and roses and stocks continue growing to the sky.

The YC2YR chart is the yield curve represented by the 2-10 spread. This is the 10-year yield minus the 2-year yield. If you move the decimal point over two places that is called basis points, or bips. The 0.51 percentage-point yield spread above is also 51 bips. The yield curve can be measured across any maturity. The 5-30 spread is a popular metric. In addition, there will be interesting things happening inside the yield curve among the various 2, 3, 5, 7, 10 and 30-year yields. The 2-10 spread fell to 48 bips lat week very briefly.

The 10-year Treasury note yield is at 2.48%. The 2-year Treasury yield is at 1.96%. The 2-10 spread is at 52 bips. The 2-10 spread is the most popular metric for assessing the yield curve and the 5-30 spread is a close second.

Sticking with the pundit's proclamations, the chart shows the yield curve inverting back in 1998. The blue line at zero that is where you subtract the yields and the result is a goose egg. If the yield curve inverts, by definition, the 2-year yield is rising above the 10-year yield so when you subtract the 10 from the 2 you get a negative number. That is shown by the full-blown yield curve inversion in 2000; also 2006-2007.

With the yield curve inverted in 1998, the stock market did not peak-out until March 2000 so why worry now, be happy, as the pundits say nowadays. In 2006, the yield curve inverted, and the stock market did not peak-out until October 2007. Based on those two examples, you can see why the talking heads are proclaiming no worries for the stock market. They say it will take another year for the yield curve to invert, then another year or two before stocks top out. Then they throw confetti, sip Fed wine, and buy stocks.

Lets take a more balanced look at the story, however. A bear market can occur in stocks without the yield curve inverting. Someone in the back of the crowd yells, "Blasphemy!" There are actually five noteworthy times that the stock market slipped into bear markets, which is a drop of over -20%, without the yield curve inverting including 1962, 1976-1978, 1987 going into the crash, 1998 and 2011. So the pundits can put this in their pipes and smoke it.

The yield curve was dropping in 1996-1998 and stocks fell off the wagon without the yield curve inverting. In fact, a similar fractal may be occurring now (blue boxes). In 2011, the SPX fell from 1380-ish to 1065-ish, 315 points, -23%, bear market territory, while the 2-10 spread was up at 175-280 bips.

The Federal Reserve and other global central bankers have destroyed all price discovery in markets. All assets are pumped to bubble highs since the world is awash in liquidity. The central banker have destroyed expected business and economic cycles with their obscene Keynesian monetary policies. The final act of the theatrical drama has not yet played out.

It is probably best to disassociate the stock market future direction from the yield curve and if anything, expect the stock market to roll over without an inverted yield curve. That will surprise everyone considering that they are all on the boat that says an inverted yield curve is a year or two away and a stock market top is 2 to 3 years in the future. That boat may begin springing leaks.

Technical analysis-wise, the green falling wedge will get your attention. This is a bullish chart pattern. The indicators are possie d (green lines) and RSI and stochastics are at oversold levels wanting the spread to move higher (wider). All these factors point to a bounce in the spread ahead in this weekly basis but note the apex of the falling wedge is a bit lower. So the spread may bounce along sideways through that purple channel this year neither widening to any great extent nor narrowing to the zero and inversion bound.

Keystone is finishing the 2018 predictions a work that would rival Hemingway's, so these mental exercises are important for long-term forecasting. If the expectation is that the 2-10 spread will bounce through the purple channel this year and maybe into next, how will that manifest itself? Of course the spread is widening but does the 2-year yield stay anchored while the 10 rises, or does the 10-year yield run wildly higher with the 2 anchored, or do they both move higher only the 10-year faster? or do the yields both move lower with the 2-year yield dropping faster? Such mental machinations require frequent aspirin.

The wage numbers are sick. Inflation cannot exist without wage growth occurring. If inflation does not occur the Federal Reserve's grand 9-year experiment into 'Keynesianism-Gone-Wild' will end in failure. But not complete failure since the privileged elite class in America, the top 20 million people, have become filthy rich over the last nine years since they own large stock portfolios.

The Fed's easy money was not used to buy equipment or hire workers instead it went to buybacks (stock repurchase programs) which only serve to pump the stock prices higher so the wealthy become more wealthy. The Fed members are rewarded with big kickbacks from the investment banks when they retire; a quid pro quo for their allegiance to dovish monetary policy. This is the crony capitalism system in America. It's not rocket science. Corporate executives will use the tax savings under the new tax bill for same. CEO's are out this Sunday looking at new yachts.

The sick wage numbers say inflation will remain Godot in 2017. This means the Fed will not hike rates three times as expected this year. Many market participants expect Fed hikes in March, then June then December. If inflation is not occurring and the economy softens, and the Fed stands pat, the 2-year yield will likely retreat while the 10-year yield remains more anchored. No one even talks about such a potential scenario.

What does all this wind-bag talk say? Simply that do not allow yourself to think that the stock market can only begin an extended multi-month and multi-year down move after the yield curve inverts. That is simply wrong. Watch your wallet. This information is for educational and entertainment purposes only. Do not invest based on anything you read or view here. Consult your financial advisor before making any investment decision.

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