The bearish stock market scenario in one chart

While the overall economic picture in the US is stable, there are several hints that investors are less optimistic about prospects for the future. The US Treasuries yield curve has flattened gradually since the end of last year (and significantly since the "taper tantrum" period in the second quarter of 2013). Just look at the spread between the 2-year and 10-year Treasury notes: 95 basis (as of May 13) points is the lowest level during a period of declining spreads since December 22, 2007 (month marking the official start of last recession). We've seen tons of bearish calls for the markets over the past 4-5 years (I've certainly miscalled some in the past), but long-term investing in stocks seems especially risky if bond markets are potentially telling us that investors are less confident in the US economy's strength (the flattening of the yield curve could also be due to expectations of further rate hikes by the Fed, but we've seen swaps suggest that those expectations have been pulling back).

I find the present chart, which compares the Consumer Discretionary Select Sector SPDR (IXY) and the Consumer Staples             Select Sector SPDR (IXR) particularly interesting. Up until last November, the IXY had been performing better than the IXR on a relative basis (IXY is the denominator of the ratio I used here). But the most recent broad market correction saw a sharp reversal in this trend (about 20%). Technical analysis remains a valid tool for price ratios between two assets, and my take on this chart is that if this particular ratio were to break above it's February highs, that may signal a change in the long-term dynamics in the broader market. I estimate that this would need to happen sometime during the 3rd quarter for the momentum behind another stock market correction to really push investors to flee cyclical stocks in favor of defensive stocks and safety assets over a longer period of time.
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