Top Advisors Corner

Tom McClellan: When the Flight to Quality Goes Too Far

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The stock and T-Bond prices often move in opposite directions, and, as of August 2019, that movement has reached a pretty extreme degree. The basis for that statement is from the indicator in this week’s chart, which comes about through some fairly simple math.

I calculate a 10 trading day rate-of-change (ROC) for both the SP500 Index and for near-month T-Bond futures prices. Then, I find the difference between those two expressed in percentage points. It is a very short lookback period, not intended to represent “investment” returns but rather to capture extreme movements which may have interpretational insights about the two markets.

The current, deeply negative, reading is officially low and in small company in terms of past extreme readings. All of the similarly extreme negative readings have been associated with important lows for the stock market.

Interestingly, the very high readings do not have the same meaning. Seeing a reading up around 8 percentage points or higher for this spread indicator typically marks the initiation point of a strong new uptrend, as opposed to an overbought top. This has been one of the most important points I have learned as a stock market analyst: Up and Down do not behave the same in the stock market. They may in other markets, but, for stocks, the highest upward momentum is typically seen at the start of an advance, while the highest downward momentum typically marks the bottoms for stock prices. 

One additional point worth noting: The day with the biggest negative reading for this spread indicator is not necessarily the final bottom day for stock prices. The prior extreme low reading came on Dec. 18, 2018, which was 4 trading days ahead of the lowest closing low for the SP500 on Dec. 24, 2018. So, while we are getting a message that an important price low is forming now, it does not have to be here yet.


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