Concern for man and his fate must always form the chief interest of all technical endeavors. Never forget this in the midst of your diagrams and equations. - Albert Einstein
On November 10, I wrote an article titled “Italy Changed Everything: Implications for the Fall Melt-Up” in which I stated emphatically that “Italy changed everything.” And while October ended up being one of the best decades in history for risk assets, the conditions that favored a continuation of the move higher into year-end deteriorated as Italy, and now Spain, overnight became the next great concern. I have turned increasingly negative on markets in the past several days as market internals have weakened in response to the realization that we may be hitting a crescendo in the eurozone.
Italy and Spain are not Greece – they are far bigger and far more consequential to the global financial system and specifically the existence of the euro itself. Furthermore, while many “knew” Italy and Spain would be next, the issue is the speed at which yields have spiked, which may be creating a powerful negative and self-reinforcing feedback loop. Barring some kind of immense response in Europe, it appears that every day puts us closer to some kind of an “event” that could significantly disrupt markets worldwide. This goes beyond money – this goes to a societal concern that transcends numbers on a screen and dollar signs.
This indeed may be what Treasuries are sensing with the 10-year around crisis 2% levels. A continuation of the Melt-Up needs to be confirmed with rising yields (which occurred in October). The fact that yields have collapsed again while equities remain elevated is a significant disconnect worth paying attention to. Take a look below at the price ratio of the 7-10 Year Treasury Bond ETF (IEF) relative to the S&P 500 (IVV). As a reminder, a rising price ratio means the numerator/IEF is outperforming (up more/down less) the denominator/IVV. Don't focus on the ratio number itself – focus on the trend of outperformance.
(Click chart to expand)
Notice the panic spike that occurred at the very end of September, right before the October rise in equities that sent the ratio down in a sharp way. However, the ratio hit a low right at the end of the month, and has since stabilized with what appears to be a renewed trend higher just starting. While admittedly in its early stages, the fact that absolute yields are as low as they were before the October break in the ratio means that all-else-being-equal, the ratio likely is not justified at its current levels. Because equities tend to act with a lag, it could be that the yield/ratio disconnect gets resolved in the coming weeks, right as December starts.
We go back to the same question that has plagued markets all year – is the bond market right? Are we headed for a period of global contraction and deflation? If it is, equities may be in for a rude awakening, resulting in what could be a December to Remember, i.e. a repeat of the move down experienced in August and September.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.