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Negative Divergence between Treasury Yields and Stocks Continues to Signal Caution

|Includes: DIA, QQQ, SPDR S&P 500 Trust ETF (SPY)

The following commentary was initially published on May 13, 2011.

In April, we observed the development of a negative divergence between treasury yields and stocks. While the S&P 500 index moved up to a new long-term high in late April, the yield on the 10-year Treasury note returned to previous short-term lows. Since then, yields have moved down to new short-term lows as stocks have consolidated below recent highs of the cyclical bull market.


This divergence is a warning sign that suggests the S&P 500 index has become vulnerable to the development of a potentially sharp decline and a confirmed break below power uptrend support near current levels would predict a relatively quick move down to long-term uptrend support in the 1,300 area. Additionally, the current treasury yield short-term cycle has an extremely bearish translation, suggesting that yields are likely preparing to move even lower following the formation of the next Short-Term Cycle High (STCH) sometime during the next several sessions.

As always, there are no certainties when it comes to financial market forecasting, only possible scenarios and their associated probabilities. However, short-term technical and cycle analysis both suggest that stocks are vulnerable to an abrupt decline, so elevated caution is warranted at this time.