LONG BONDS AND THE YIELD CURVE

Two weeks ago we said to look for one final rally in the S&P 500 as long as the 1160 level held up. It is not lost on us that once again stocks show they can only rally if long term yields and the dollar are not rising. But this trend should soon come to an end.
Below we feature our “investment nirvana” theme that depicts when investors fear neither stock market losses nor inflation. We represent this by dividing the T-bond by the Vix. Recall that in December 2004 this ratio tested its all time high of 10 seen exactly ten years ago in December 1993. Importantly, the previous top coincided exactly with the Fed’s rising interest rate cycle that began in February 1994 after having held rates at 3.0% for 17 months following a rate cutting cycle that began in July 1990 at 8.0%.
Note how there was a final surge in T-bonds as the steepening yield curve reversed direction and began to flatten. Then, when the ratio between the 30-year bond yield and the 3-month money market fell to 2 (30-year at 6% and money market at 3%) the bond market peaked and began to head sharply lower. This coincided with a peak in the Bond/Vix ratio as well. Interestingly, the exact same set up is occurring now in the Treasury bond.