Goldman: "As In Mid-June The S&P Looks Very Overvalued Relative To Yields"
Even as stocks continue to ignore the broader economic decline, and trade exclusively to kneejerks on one-time items such as Goldman's settlement and BPs pressure tests, the far more liquid and rational bond market is hunkering down. Today, the 2 Year hit an all time low yield, even as the 2s10s tightened by yet another 6 bps to 240 bps. The impact of today's curve flattening alone will have a far more profound impact on Goldman EPS than the latest SEC wristslap farce. And as we pointed out previously, the spread between the S&P and the 10 Year yield continues to diverge. In fact, it is now so wide, that in the latest John Noyce piece, the Goldman Strategist says: "As in mid-June, the S&P looks very overvalued relative to yields. Yields are also beginning to decline again as equities stall." Sure enough the reverse is also true, and bonds may be rich to stocks, but either way, we reiterate our observation that the short stocks-short bonds trade will eventually converge (luckily with the yield on the 10 Y so low, the carry is marginal and the repo rate will likely be a greater burden until the spread recouples).
Here are some additional observations from Noyce.
- This is an update on a correlation chart we’ve looked at a number of times over the last few weeks.
- It shows U.S. 10-year yields in green overlaid with the S&P in blue.
- The correlation between the two has turned increasingly positive over the last couple of months.
- At this point a similar setup appears to be developing to that which came together during the second half of June (the numbering below refers to the stages highlighted on the chart opposite):
- The rise in equities stalls and yields again begin to turn lower
- Yields continue to drop, and eventually equities also turn down, re-coupling with yields
- Overall, the S&P now sits just below significant resistance centred on 1,093-1,112, and a similar yield/equity divergence is developing to that seen during mid-June. We should begin to watch very closely for signs of equities peaking and again turning lower.
Noyce also has some bearish non-correlated technical observations on the S&P. Specifically, he sees the 1,093-1,112 level as a major resistance in a Right Shoulder formation. Also, a comparable bounce off lows into the 55/200 DMA was last seen in November 2000, when the market proceeded to subsequently drop notably as the tech bubble burst.
- There are two main points to make with regard to the price action seen on the S&P over the last week;
- The market has recovered sharply from the lows of early-July close to 1,000. The bounce has been similar to that seen following the comparable negative 55-/200-dma cross-over in November ’00, as a structural top was in the process of forming. 1,093-1,112 should now act as strong resistance and the easy part of the bounce could well have run its course. An update on the historic comparison chart is shown on the following slide
- Assuming the market is currently forming the right shoulder of an H&S topping pattern and that the time period taken to form the two shoulders should be similar, the current consolidation could run until mid-August, and likely remain within an approximate 1,100-1,000 range.
- In conclusion, a deep and sharp recovery over the last couple of weeks, but one which is currently within the constraints of what can be considered as part of a larger structural top forming. The topping process could be considered to have another 1 to 1.5 months to run given how long the left-shoulder took to form. The historic comparison with November ‘00 does however argue we should be near the top of the range, with 1,093-1,112 good resistance.
- The last time a –ve 55/200-dma cross over took place (55-dma falling through an already declining 200-dma) was in November ‘00.
- It was an important signal from a LT (multi-month) perspective, however, the averages were re-tested as resistance before the market again fell away.
- So far things are playing out similarly this time around. The negative 55-/200-dma cross over is in place and the market has come back to test the moving averages as resistance (the downtrend from the April highs and 55-/200-dmas being converged 1,093-1,112). While the market need not fall away again immediately, the similarity of the current setup to November ‘00 is quite striking. Another eventual down move does still appear the most likely outcome.
Then again, in a market in which Hurst Coefficients are approaching one, precisely the opposite of what one expects to happen, happens. Although for those who wish to gamble, a safe decoupling has just occurred between S&P futures and the AUDJPY. After tracking each other perfectly all day, the two have diverged notably after hours. Buy the AUDJPY, sell the ES, wait for convergence number 18 in a row to occur, and pick some free non-taxpayer subsidized points from your broker.
5
