Hello Fellow ChartWatchers!
Once again, the September-October part of the year
is turning out to be a very important time for the markets. The
Nasdaq is closing in on 2000, the
Dow is taking aim at 9750, Gold
is higher than it's been in almost 7 years, and the
Bullish Percent charts remain at ridiculously high levels. This
is a great time to be a Chart Watcher!
Later on in this issue, John
Murphy and Richard Rhodes both point out some reasons for caution while
Carl Swenlin presents an in-depth article on one of Rydex's new ETFs.
Also, be sure to read about the big changes that the CBOE just implemented
for their Volatility Index ($VIX). But first...
Touring
the Yield Curve
One of the least used tools on StockCharts.com
- our Dynamic Yield Curve chart - was in the news recently as the Federal
Reserve decided to leave interest rates unchanged for now. I thought
it'd be a good time to review this chart and see what it can teach us
about bull and bear markets. You can find the link to this tool
on the left side of our home page or at the bottom of our "Free Charts"
page. It's a Java applet and when it appears, you should see something
like this:
On the left side is the Yield curve itself - a plot of bond yields by
bond duration. The black line is the yield curve for "today"
(19 September 2003 - see the date in the lower left corner?) and the blue-green
lines show what the yield curve was during the last 30 days. On
the right side is a chart of the S&P 500 index. For more details
on how the yield curve is constructed, see the
Glossary entry in ChartSchool.
We call this our Dynamic
Yield Curve chart because you can click anywhere on the S&P 500 chart
and see what the Yield Curve was at that particular time. For instance,
if I click near the start of 1996, I instantly see the following:
Wait a second... Look at the
difference in the shape of the yield curve on the two charts above.
While the long-term (30Y) yields are pretty similar (~5%), the short-term
yields are very different. In 1996, in the middle of a huge bull
market, money was tight and short term yields were almost as high as long
term yields. Right now however, those yields are more than 4% lower!
Let's see what happened to
bond yields between 1996 and now. You can do that with our
Dynamic Yield Curve by either clicking and dragging your mouse along
the S&P 500 chart, or by clicking once (around Jan. 1996) and then
holding down the right arrow key on your keyboard.
In the first half of 1996 (above),
the yield curve looked like a relatively straight line. During 1996,
it quickly regained its typical sideways-"L" appearance and
then moved to its highest levels during July just before the market dipped.
When the market quickly recovered in August, long-term yields briefly
returned to their high level but then fell throughout the rest of the
year.
The next market "hiccup"
happened in April 1997. At the end of March, long-term yields were
setting new highs again in the 7+% range. Stock fell sharply in
the first week of April, but recovered quickly. This time however
yields remained relatively high throughout the "dip" as the
chart below shows.
Over the next 16 months, yields
slowly fell and once again the yield curve flattened out. It is
interesting to note that short-term yields had not moved much up to this
point in our journey. They have been "pegged" so far near
5% since before January 1996. The Asian Currency Crisis in 1998
would change all that however. It started on July 21st, 1998.
The yield curve reached its low point on October 5th, leaving us with
a very dramatic chart:
In just over two months, short-term yields had fallen almost a full percentage
point. See how broad the blue-green area above the black line is?
This tells us that the decline was quick and that the straight
shape of the yield curve remained relatively constant. When yields
started to rise again, short-term bonds lagged the long-term bonds.
It was only after the curve regained its sideways-"L" shape
that short-term yields started to rise once more.
The yield curve continued to
rise (are you following along on the
dynamic chart?) throughout 1999 and early 2000 but on January 26th,
2000 a very important thing happened - the 30Y yield fell below the level
of the 10Y bond officially signaling an inverted yield
curve.
This was followed by a period
of very different looking curves as the bull market ended and the bear
market began. Horizontal lines, regular "J" shapes, irregular
"J" shapes - you name it. The "goofiest" curve
may have happened on October 23rd, 2000. On that date, short-term
yields were higher than the longer term bonds - a situation that only
makes sense in a deflationary economy!
It wasn't until after the market
bounced in May of 2001 that the typical sideways-"L" shape returned.
After September 11th, short-term yields dropped dramatically again - reaching
their lowest point on January 14th, 2002:
It's helpful to stop at this
point and compare the yield curve above (from the heart of a bear market)
with the one from from the bull market period earlier in this article
- the 30 April 1997 chart for instance. Note how much lower the curve
is on the chart and how much larger the difference is between the short-term
yields and the long-term yields.
We've got one last stop on our
guided tour - the market bottom that happened in October 2002 (or possibly
March 2003).
The interesting thing here is
that nothing interesting happened to the yield curve. It didn't
change in any dramatic way at those turning points, nor has it changed
too much from then until now (see the chart at the very top of the article
again to see what I mean). Certainly, nothing as dramatic as what
happened at the bull market top.
Sorry for all the
charts in this article, but I hope this has helped you see the value of
this nifty free tool. Check out our
Dynamic Yield Curve often for a unique perspective on the
markets.
- Chip Anderson
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