Keystone's 2-10 Yield Spread Indicator

We have been monitoring this drama for the last couple months and more. The financials are the new darling of traders and are expected to lead the broad indexes higher this year. JPM will kick off bank earnings tomorrow. Keystone uses a 255 spread as the signal line distinguishing happy banks from sad banks. The higher spread 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. The higher yields 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 0.37% and the 10-year note yield is 2.86% resulting in a 249 basis-point 2-10 yield spread. The spread increased to about 264 last week as the 10-year yield climbed a touch above 3%, but, since the jobs report, yield has collapsed. Traders, analysts and strategists started celebrating when the spread hit 264, drinking heavily, but now at 249, they are frantically trying to return the corks into the wine and champagne bottles. The jury is out on this drama. As long as the spread remains sub 255, traders better keep the corks in the bottles and dampen expectations over happy banks ahead. Above 255, and they can par-tay.

At the market bottom in March-April 2009, the 2-10 spread was about 200 signaling the ongoing turmoil. In December 2009, the spread was up to 288 with drunken bankers toasting Chairman Bernanke's QE policies as the yield curve steepened. 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 ever since. This summer, 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), this is where the yields reversed dropping the spread from 250-ish back down to 220-ish. Then came the big push higher in the 10-year to near 3.00%. The bankers could not resist; they popped the champagne corks and started drinking. They have been drinking ever since but now drownign their troubles as the 10-year yield collapses under 2.90%.

Thus, the coast is not clear as yet. Perhaps all the talking heads telling you to buy financials may prove to be correct, however, the charts are not in their favor either. Even though banks may be making money due to the steeper yield curve this does not necessarily reflect in the stock price so this must be kept in mind but in a general context, happy banks with happy steeper yield curves make for happy stock prices. The XLF (financials sector ETF) moves higher as the momo and trader interest increases. The stock market simply goes up due to the Fed money-printing. The Fed is the markets and equities continue to climb a wall of Fed.

Traders may be putting the cart before the horse thinking that yields will now continue their upward move non-stop and send bankers and the stock market higher. Watch the 255+ spread to see if the steepening yield curve is the real deal, or not. Keystone's current projection is continued sideways and sideways lower price action for the financials ahead and the spread will remain 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. The inflation, and perhaps hyperinflation moves, are likely months and years away still yet. The 18-year stock cycle remains in a secular bear currently until 2018. Even if this important cycle is left-translated this time around, that would be 2016-ish as the bottom for the secular bear which may indicate a sick period of disinflation and deflation with flat rates continuing for the next 1 to 3 years, at a minimum. Watch the 255 number for the 2-10 spread to gauge if the talking heads are correct about happy banks ahead, or not, and definitely watch the financial tickers XLF (which did pop above the 21 resistance now at 22 but negatively diverged), $BKX, KRE (regionals making new highs but negatively diverged), JPM, GS, BAC, C, MS, etc...