By: Steve Smith
We’ve discussed the rise in interest rates and what the implications for the stock market could be, mostly from a fundamental standpoint. Today, we’ll be looking at a more technical take, but first, a recap. A steadily improving global economy seems to be driving yields higher, which has allowed central bankers to reduce or eliminate quantitative easing programs. Here in the U.S. this has allowed the Federal Reserve to take a steady path of interest rate hikes.
The result is that the yield on the 10-Year Note has now moved above the psychological 3 percent level and closed at 3.06 percent, its highest level since 2011. The upward trend seems firmly in place, and we’ve recently made several bearish trades in the iShares Barclay’s Bond ETF (TLT).
JC Parets has applied some technical analysis and has also reached that conclusion. Here’s his take:
I’m not the kind of guy that likes to give funny names to price patterns in the market. For me, it’s more about the implications of that market behavior and less about what we call it. Today I want to take a look at US Treasury Bonds and what some price observers might refer to as a ‘Head & Shoulders Top’.
The reason this is a popular pattern is because, as humans, it is easy for us to identify and relate to. Each of us have a pair of shoulders and a head that stands in between and above them. In today’s chart, the Head and 2 Shoulders are fairly easy to point out. We’re looking at the US Treasury Bond ETF $TLT:
After the epic rally in US Treasury Bonds throughout 2014, prices put in a high to start 2015 before rolling over. When stocks sold off in 2015 and into 2016, you can see bonds had another rally, and even made a higher high. I’ve been arguing that this high in bonds in the summer of 2016, the low for interest rates, was the beginning of the new bull market in stocks that is not even 2 years old yet. You can read my piece in Modern Trader Magazineand this is one of my higher probability outcomes, rather than the misleading headlines they feed you about a 9-year old bull market.
When stocks really started to rally into the end of 2016, bonds got crushed. This was the end of the bull market in bonds, in my opinion, and the start of a bull market in stocks. We’ll call this the “Head” of the potential Head & Shoulders Top setting up in bonds.
After one more rally attempt in $TLT in the second half of last year, prices are now back to key support:
This potential support level in $TLT is near 116-117 and is marked by former support from the past couple of years as well as the 61.8% retracement of the entire 2014-2016 rally. I think if we are below 116 in $TLT, we want to be short bonds with a target back down near 100, where we bottomed in early 2014.
The implications here are likely to be seen all over the world. Where is that money going to flow as it comes out of bonds? Well, based on the weight-of-the-evidence, my bet is into stocks and commodities.
Related: Are Tech Stocks Headed for a Fall?