Old Trader's  Instablog

It is often said that one shouldn't speak in generalizations, nor stereotype things. Still, it may be worthwhile to remember that the reason that generalizations and stereotypes come into existence; is that they're correct, more often than not.

There's no shortage of generalizations, when it comes to markets, and investing. "Sell in May and go away" springs to mind, as well as thoughts of "Golden Crosses", "Death Crosses", and "Hindenberg Omens".

Perhaps not quite as common, but with more than a few adherents is the thought that the bond market's "smarter" than the stock market, and keeping a weather-eye cast in the direction of the bond markets can provided a timely warning of trouble brewing in equities.

An old standby for investors and traders with longer timelines than a week is the shape of the yield curve. Traditionally, an inverted curve (meaning that short rates are higher than the long rates) has not boded well for equities. For quite a while, the curve has had a mild upward tilt to it as the Fed leaned heavily on the short end of the curve in an effort to stimulate the economy.

Still, the curve has slowly trended towards flat, as events in Europe have driven periodic flights to quality. With the announcement that the Fed will, in fact, implement "Operation Twist", the markets ended up selling off sharply.

How likely is it that the Fed's next plan of action will precipitate an inverted yield curve? By eliminating the support on the short end of the curve, and shifting assets to the longer end, it seems to me that short rates would have a tendency to rise, while the long end would be pressured downward.



Disclosure: I am long GIM, TEI.