I was looking at old charts from June. Remember when the stock market was correlated with movements in the 10-year Treasury bond? Compare the results in the following graph. The 5/3 – 6/10 numbers versus the 6/11 – 9/24 results is day to night.
The level was 96% back then. That’s a hell of a number. More or less it means that things were lining up nearly perfectly. As of late the correlation has fallen to 3%. Some random thoughts:
- My conclusion is there is a lot of risk involved with correlation trading. What is here today is gone tomorrow. Reliable predictors do not have much shelf life any longer.
- What is the source of the disconnect? Strong stocks and strong bonds in this time period coincide with the emergence of QE-2 talk from Ben Bernanke. Back in May the thinking was that the next move by the Fed would be a gradual withdrawal of monetary stimulus. Today the betting is that Ben is going to throw another $2 trillion on the fire. This turn around in thinking by the Fed and the market disconnect is not a coincidence. It is cause and effect.
- Is there an inverse relationship between the movement in the stock market and the probability of QE-2? I am willing to bet big that
IF stocks were to fall by 10% between now and the next Fed meeting, QE-2 would be a done deal. But what if stocks rise by another 10%? Can Bernanke throw gas on the fire if that were to be the case? I have to think not. So the question is,“Is Ben wishing for higher stocks today or not?’
I think he wants a downdraft so he can justify another QE early in November.
- Clearly the 96% was not sustainable. The inverse (3%) is probably not either. Should the old relationship start to re-appear it would imply that rates have to go much higher or stocks much lower. Place your bets.