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Stalking The Bear – Part 2: A History Lesson: When Equity Prices Ignore Treasury Weakness Trouble Brews

Before I begin, I’d like to make clear the purpose of this post. I am not attempting to call the top of the equity market nor am I suggesting a portfolio should be aggressively short at this time.  Take a good look at the mission statement above. These posts are designed to make you think, stay aware and avoid the trap of complacency constructed by traditional financial media outlets.

That said, I think the rally is over, the equity markets have topped and a massive short position is in order (KIDDING, KIDDING!!!)  Just a little levity bringing some color to a world that is all too often monochrome.

In my first “Stalking the Bear” post I wrote about the potential negative effects of interest rate creep. Well, the creep is turning into a trickle and should that advance into a stream then things could get interesting.  Treasury rates briefly popped above 4% last week as an ever increasing amount of government debt issuance flooded the markets. This flood comes at a time when the Fed is supposedly ending the quantitative easing plan of buying MBS.  It remains to be seen whether or not the Fed can stay out of the MBS market with rates jumping higher as the story below reflects…

At 5.21%, Freddie Mac 30 Year Fixed Rate Mortgage Jumps To Highest Since August

Yesterday we reported that the MBA announced the highest average 30 year FRM rate since August: a jump from 5.04% to 5.31%. Today this deterioration in mortgage rates was confirmed by Freddie Mac, whose 30 year Fixed Rate Mortgage jumped from 5.08% to 5.21%. Whether this is a function of the recent surge in 10 Year yields (subsequently ameliorated by Chinese purchases during yesterday’s auction) or of the end of QE finally being felt is uncertain, although it is probably a combination of the two.

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Meanwhile, as Treasury rates increase and mortgage rates advance the equity markets drift higher. Throughout history, this type of divergence has been dangerous for equity investors.  Rates will need to come back down (assisted by renewed Q.E. no doubt) or at some point equity prices will adjust and if history is a guide the adjustment will be fast and furious.

Below is a graphical representation of the growing chasm between stock and bond prices courstesy of GMT

  1987

Now, compare the above divergence to the debacle of 1987 depicted below and you will understand why we are “stalking the bear”.  Timing events is not easy and divergence can last for weeks or even months. Awareness is your only weapon; wield it wisely.

sptlt

 


Disclosure: no positions