Treasury-Bund Divergence

Breadth divergences are just now starting to appear in the stock market, but there is another bearish divergence which has been operative for a few months.  This week's chart shows an interesting relationship between the stock market and the spread between yields on US and German debt.  Specifically this spread compares the US 10-year to the equivalent "bund".  That term is short for "Bundesbank", the German central bank.  Bundes means federal in German.

Normally this spread goes up and down in step with the stock market.  If it ever gets negative, meaning bunds having a higher yield than Treasuries, that is a great condition to be a US stock investor.  We have not seen one of those since 2009.  A high positive spread means that Treasury yields are a lot higher than German yields.  When that condition appears it is a sign of trouble for stocks.  But that trouble does not necessarily have to come right away just because of a high reading.

Problems for stock prices tend to become much more immediate when there is a divergence between stock prices and this Treasury-Bund spread, and that is the condition we are seeing now.  Divergences like this one are associated with problems for the stock market.

The problem with any divergence is that it will not tell you when it is going to matter.  It just says that there is a problem.  That condition can persist for a month or two, or for even longer, and the divergence won't reveal the timing of the inflection point.  It is also possible for a bearish divergence to get "rehabilitated", which takes away the bearish message.  That would take a lot of work in the current case, given how far this spread has dropped already. 

It is worth noting that this relationship between the Treasury-Bund spread and the stock market did not really work before the early 1990s.  German reunification happened on Oct. 3, 1990, following the fall of the Berlin Wall on Nov. 9, 1989.  That reunification, and the eventual creation of the euro currency in 1999, changed a lot of financial market relationships, and brought this phenomenon into effect.