Real growth and real interest rates are improving? That is the theme I heard yesterday for the first time in a long time. If the rumor or projections are true, the upside to this market may be just beginning. The last time the US markets experience real growth relative to the economic cycles was in 1993-1999. Interest rates were in a steady 5.5-6.5 percent range, gold prices fell from above $400 to the $250 range, the dollar index moved above 100 and the S&P 500 rose from the mid 400 level to just above 1500. Are we heading towards a similar cycle for the US economy and stocks?
The first thing I would be quick to point out to those who are raging bulls, one day of interest rates moving higher, gold moving lower, the US dollar getting stronger and stocks breaking above resistance levels, doesn’t indicate a real growth rate shift in the US markets. Yes, it could very well be the first step if all the pieces come together, but let’s not break out the champagne just yet.
Putting the moves in perspective is key as well as tracking and watching how things progress moving forward. The first chart below is the ten year Treasury bond yield. There have been more predictions of bond prices falling and yields rising than I can count. I have written my share of warnings over the last two years, but with a free-money Fed policy rates have declined to historically low yields. The lows of 1.71 percent last fall also set the low for the S&P 500 Index. Yields have struggled to break above the 2.1 percent level until Wednesday when they moved to 2.27 percent. Technical breakouts have to be confirmed and the new trend established. This new trend will take time and to make it more challenging, it is a trend reversal. One day is not a trend, but this development is worth watching and trading.
A look at the chart below of IEF, iShares 7-10 Year Treasury Bond ETF shows the downside risk of higher rates to US Treasury bonds. If the yield were to continue toward the three percent mark, the impact to bond prices will be significant. The play would be to short Treasury bonds. TBX, ProShares Short 7-10 Year Treasury Bond ETF is the simple way to short the bond without leverage. (Volume is extremely thin, but it is available.) PST is the two times leverage inverse fund which has ample volume, but you have to respect the leverage and the time horizon you are looking at holding the position. Measure the risk and time frame before investing in either fund. Thus, the positive signs in interest rates does create an inverse opportunity in the bond or at the very least and exit signal for Treasury bonds if you won them.
The other variable we discussed above is falling gold prices. The chart below of gold shows first, the extreme volatility in gold recently. In addition the current drop from the recent high of $1792 is in play with a target or support level at $1560. The move is dramatic in nature with respect to volatility and time frame, but it is not a deal breaker from a longer term perspective. A significant break below the $1560 would indicate a long term trend reversal and worthy of validating the return to a real growth environment for the US economy. Short term the drop in gold is creating a buzz and opportunity to entertain a short play.
A stronger dollar is another part of the equation and the chart below of the dollar index shows a solid rise in the buck since last September. It has happened with its share of volatility, but it has progressed higher nonetheless. The dollar will face some key resistance at the 81.50 mark, but if interest rates continue to rise and economic data continues to improve the move will push through with the potential to test the next level with a goal of moving towards 89. UUP, PowerShares US Dollar ETF is a simple way to play the move higher. Remember, a stronger dollar is negative relative to the price of crude and the move over the last ten days in the dollar has stalled the advance in the price of crude oil. Watch for further improvement in the dollar if this all unfold.
The last part of the puzzle is stocks take on broad leadership as money migrates from alternative assets back to stocks. The chart of the S&P 500 index shows a similar picture to the rest of the pieces… money is flowing back towards stocks and the index has responded with a positive short term uptrend. The break above 1370 this week is a positive move for the index and the advance of stocks. We have to watch the progress of the trend as it develops moving forward.
The real growth of the US economy and stocks is a possibility. All of the pieces are lining up and the opportunities are beginning to play out. We can take advantage of all the parts, but we still have to monitor and validate the move at each step of the way. There will be periods of doubt accompanied by selling as we progress along the way. We have the tools to manage the risk as well as the opportunity. Over the next five years we can look back and say, it is or was a period of real growth and we made money. Or we will look back and say what where we thinking, the growth never developed and it was just another short term move in a longer term downtrend? Either way we stand to make money by following our beliefs and managing the risk along the way. Right or wrong risk management leads to better money management.