A composite indicator constructed from the trends in yields on the 10 year Treasury bond, gold and the CRB Index suggests that inflationary pressures have decreased. The indicator is shown in figure 1, a weekly chart of the SP500. I last discussed this indicator and its significance in this recent article.
Figure 1 SP500/ weekly
Last week, yields on the 10 year Treasury were decimated, and this has brought the composite indicator out of the extreme zone. With the announcement of QE3, yields on the 10 year Treasury shot higher, and my interpretation was that market participants were anticipating inflationary pressures. This appears to be wrong. Higher bond prices (lower yields) are consistent with economic weakness. At this point, the question to ponder is this: will economic weakness trump QE3? In other words, will economic weakness exert its effect on equity prices or will QE3 continue to buoy equities? With the Fed gone from the equation — remember they are all in — it is not unreasonable to think that QE has lost its magic. As stated last week, extremes in the indicator typically are seen late cycle and have preceded some of the ugliest market downturns including 1987, 2000, 2002 and 2008.
The take away message is that economic weakness may trump QE3.