U.S. Treasury Bond Market Is Signaling Stock Market Trouble Ahead

Stock-Markets / Stock Markets 2010
Aug 18, 2010 - 07:11 AM

By: Claus_Vogt

My outlook for the economy and the stock market has steadily and significantly deteriorated since March 2010. That’s when monetary indicators started to signal renewed emerging stress in the financial system, and leading economic indicators started heading south.

The stock market was richly valued in terms of dividend yield and price/earnings ratios. And I predicted a topping formation followed by a new bear market. Since then the market has moved nowhere.

Price movement since last October looks like a well-formed topping formation. Longer term trend-following instruments like the 200-day moving average have turned sideways, thus confirming the topping process.

The Stock Market Is on the Verge of a Break Down

The most likely scenario now is a breakout below the lower boundaries of this topping formation — below the 1,010 level the S&P 500 reached on July 1. Such a move would definitely make clear that April’s high was THE high for the huge bear market rally that started in March 2009.

This bear market rally was indeed a huge affair. But still not out of the realms of former bear market rallies, which are mostly forgotten today. A prime example is the rally following the 1929 crash …

Stock prices rose more than 50 percent, and contemporary economists declared the crisis over. But the crash was only the prelude to the devastating bear market that got going after the bear market rally of early 1930.

The Bond Market Confirms This Bearish View

Both the bond market and the stock market are to some degree leading indicators. But the bond market is said to be the smarter one because bond traders are generally more vigilant in looking for trends in the economy.

Already the bond market is conveying an important economic message …

As you can see on the chart below, the 10-year Treasury bond yield has dramatically declined since early April. In fact, 10-year yields are as low as in December 2008, during the depth of a severe economic and financial crisis.

This pronounced slump in yields is sending a frightening message: It’s anticipating a recessionary economy.

That message fits perfectly with other leading economic indicators and with my own big-picture economic model showing that the economy is again on its way into a recession. And the picture is getting clearer by the day.

As I’ve said in past Money and Markets columns, every recession in history has been accompanied by a severe bear market …

And I wouldn’t be surprised if the March 2009 lows were broken at some point during the next two years.

Best wishes,