MEANWHILE BACK AT THE RANCH

I think most people get that interest rates effect stock prices. I am going to display a few charts today that show graphically this actually playing out over and over again. The above chart has the 30 Yr Bond in Green over layed on top of the DOW. If you look at the recent panic low in 2009, you can see the huge interest rate decline which shows as a rally in the price, of the 30 Yr Bond. At the far right of the screen we see the sharp decline in price, jump in rates, on the 30 Yr Bond. This is happening as stock prices are flying. In general this type of situation has led to some brutal price declines. The timing of this is another matter entirely. This type of condition as you will see in other examples to follow, can drag on for some time before the effect hits home.

What is the effect? People like the safety of bonds so when rates get high, investors will trade off some potential superior returns stocks offer for avoiding the risk of stocks. However, when Bond rates drop enough, investors will then drift back into the stock market willing to take on a little more risk to get the much higher potential returns. There is no magic number, it is always a relative decision depending on many other things that are going on. We cannot say that once the 30 Yr hits X %, the shift will occur, it is just not that simple. What is simple is just watching this relationship, and understanding that the air gets a little thin when we have a sharp stock rally and sharp decline in Bond prices like we are seeing right now. Once this condition is in effect, you had better have an exit strategy for when the market breaks. IT WILL EVENTUALLY.

Here are some additional examples.

You can see in both directions how this worked during these years. I have marked out what I think is likely to happen this year. With all the government manipulation of stock prices, I seriously doubt we will have a huge decline. What is more likely is a sharp shorter one like this that then takes off again. That is just an opinion, this pattern is not opinion based I just threw that in there as my two cents based on the current condition.

Of course the infamous 2000 top was telegraphed as clear as could be with this and it is how I knew to get out of all my stocks in December of 1999 and I did. The second example on this chart is a bit more tricky as we got some very sharp tradeable counter trend rallies before the actual low was formed. However, even in that case, a major low was formed pretty much right where this chart is cut off.

In summary, it is a basic fundamental that stock prices are driven/influenced very heavily by interest rates. In the past when the two instruments have diverged sharply like what we are beginning to see now, stock price reversals have taken place. There are a number of way to study this and I suggest you do this for yourself. For short term trading, this is not really of much help since you can see that these divergences can carry on for awhile. The reason they do is the collective masses don't make a decision on a dime. Money allocations take time. It is never perfectly clear what is happening until we look in the rear view mirror. This gives us a little bit of a heads up on the coming rear view mirror picture.

I expect this to very soon trigger a sharp counter trend move, followed by a massive government save of the decline. This could provide a very good short term buying spot. I am adding in one last chart for your viewing pleasure.

Good trading to everyone