Bund Spread Gives Permission for Bear Market
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In an April 2014 Chart In Focus article, I noted how the yield spread between 10-year German government bonds and the equivalent U.S. government bonds was saying that the bull market could not yet be over. The logic was that while the yield spread was still rising, the uptrend for stock prices was still underway.
German government bonds are known in the industry as “Bunds”, a contraction of the prefix “bundes” which is German for “federal”. At the major stock market tops in 2000 and 2007, we saw the peak in the 10-year Bund-Treasury spread appear well in advance of the final price tops for stocks. So because that spread was still rising in April 2014, my supposition then was that the uptrend had more months to live.
Now we see a different condition. The Bund-Treasury spread peaked at 1.81 percentage points back in March 2015, and has since been contracting. Meanwhile, the DJIA and SP500 kept on rising to incrementally higher price highs as the summer wore on, eventually breaking down with the August 2015 minicrash.
I spelled out the logic of why this yield spread indication works in that prior article. I encourage you to go back and reread it. But the summary is that when investors’ willingness to accept risk is starting to wane, that is a setup for a bear market for stock prices.
With a divergence now in place between the DJIA and the Bund-Treasury spread, we can have a reasonable expectation that a bear market for stock prices should ensue. If it plays out like the last two, the bear market should last until the Bund-Treasury spread gets back down at least to parity, or preferably even lower. That could take a while; in the 2000 and 2007 examples, it took a couple of years. The eurodollar COT leading indication already tells us to expect a downward trend until April 2016, so that gives us at least several months to see how the Bund-Treasury spread behaves.
Editor, The McClellan Market Report
Apr 03, 2014
Bund Spread’s Message for the Stock Market
Aug 21, 2015
Eurodollar COT Says Ugly Drop Is Still Ahead of Us
Jun 11, 2015
The Magic of 150 Months