Let’s cut through the charts and focus on the “Positive Correlation Creep” that’s taking place as seen in SPY (S&P 500 ETF) and TLT (a popular longer-term Treasury bond fund ETF).
SPY (Green) and TLT (Red):
In general, Stocks serve as a “Risk-On” market where money flows when economic conditions are good while Bonds serve as a “Risk-Off” market where money seeks safety from potential future downturns in the stock market or economy.
That’s an over-simplification, but it does allow a departure point for comparison of how Stocks and Bonds trend – do they trend together in the same direction (which would be a positive correlation) or do they trend in opposite directions (a negative correlation).
The chart above plots stocks (green) and bonds (red) on the Daily Chart from mid-2012 to present.
The indicator at the bottom is Stock Chart’s Correlation Tool which calculates a rolling Correlation of 60 days.
We can see what looks like an “X” pattern on the chart which highlights that bonds and stocks typically move in opposite directions; stocks have consistently moved up (bottom left to top right) while bonds have moved down (top left to bottom right).
The Correlation Indicator – with minor “blips” above the zero line in 2013 – consistently has indicated a Negative Correlation between stocks and bonds.
While that’s generally true, look closely at the “Correlation Creep” higher which I highlight with a rising green arrow on the Correlation Indicator.
Since 2013’s stable negative correlation value near -0.80, stocks and bonds have increasingly correlated over the months and we currently have a relatively stable positive correlation value near +0.50.
We can even visually see the stable rise in stocks along with a similar steep but stable rise in Treasuries/Bonds from January 2014 to present.
Take a look at the Daily Charts below of the SPY (S&P 500 ETF) and the TLT (20+ Year Treasury Bond ETF):
Both charts show a spike-reversal price low in early 2014 (January for TLT; February for SPY) which resulted in the beginning of a strong but stable uptrend for both markets.
At the same time, both markets are negatively diverging at the new2014 highs ($116 for TLT; $199 for SPY) which suggests a possible downturn or sell-swing.
It will be interesting to see if stocks and bonds both sell-off from the recent price highs, or if the markets diverge again with one turning lower and the other continuing the strong uptrend through new highs.
Nevertheless, pay close attention to the evolving relationship between these markets, especially in an environment where monthly bond purchases from the Federal Reserve are being reduced and terminated in the coming months (QE3).
This article is brought to you courtesy of Corey Rosenbloom from Afraid to Trade.