Figure 1 shows a weekly chart of the SP500. In the lower panel is an analogue chart of our bond trading model. This bond model has been bullish for 3 weeks now.
Figure 1. SP500 v. Bond Model/ weekly
Note how the bond model turned bullish back on March 26, 2010 and on March 11, 2011. Not only did these signals coincide (more or less) with an equity market top, but these time periods also signaled the end of active monetary intervention by the Federal Reserve. This was the end of QE1 and QE2, respectively. Now we have the latest incarnation of QE ending — Operation Twist. Interestingly enough, the equity market appears to be topping out once again as the bond model has turned positive.
So why is the bond model positive? Despite the low yields, bonds could be viewed as a safe haven from a fragile macro environment. While this may be true to some extent, I believe the equity weakness or bond strength (in this case) is a reflection and early sign of economic weakness. In particular, the 2011 market top coincided with noticeable deterioration in the economic data that was clearly pointing towards recession. Of course, the Fed came to the rescue with Operation Twist and the “dreaded” recession was avoided.
So in summary, a topping equity market appears to be a sign of an economy that has peaked as well. This has been heralded by strength in bonds. Most likely, this is signaling further quantitative easing as the Federal Reserve intervenes in the bond market to prop up the economy and the equity markets.