If at the beginning of 2011, anyone had forecast long term bonds returning more than 20% by year end you might expect that stocks got pummeled. Oh contrar, the S&P closed at 1,267.50 on December 30th down .04 points or 0.0%, the Dow was up a few percent and the Nasdaq was down a few percent. Given this divergence, you would think that one, equities or treasuries are extremely overvalued. I expect that in the coming weeks we will get an announcement that will shed some light on which it is.
Europe along with the U.S. dollar and the Federal Reserve’s forward monetary policy, will have a major impact on which direction price action breaks for both Treasury Bonds and equities. If European leaders don’t get a handle on their debit issues and restore confidence, things will continue to get worse. If Europe starts to falter, you might start to hear the word deflation mentioned more and more. Deflation is not something that the Fed wants they would rather have inflation. The Fed will probably step in with QEIII, over the long haul it could have a very negative effect. The implementation of QEIII could cause the dollar to fall off a cliff.
As of now the dollar is trading near recent highs in a consolidation zone. The U.S. Dollar Index is in a rising wedge pattern which could break in either direction and indicates that it is at a major inflection point. The U.S. dollar is like a valve, reacting to global market situations, and changes in monetary and fiscal policy.
Below is a chart from StockCharts.com:
U.S. Dollar Daily Chart
If the Fed lets QEII end in June as expected and does not implement QEIII, it is not clear what will happen in the bond market. When the feds first round of bond buying ended in early 2010, both stocks and bonds fell. Some experts think that once QEII ends stocks will be more resilient because the economy is stronger now, rising sales and profits at many companies should sustain stock prices. Then there are others that are worried there could be a big hole in the Treasury bond markets, who is going to step in and buy? Once the Feds buying dries up, long term rates are expected to rise and Treasury prices to fall, because interest rates and bond prices move in opposite directions.
With the implementation of QEIII, we just keep printing money and devaluing the dollar, I guess we will just wait and see.
As always whether you are long or short may all of your trades be profitable!
