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Paratrade Systems Weekly Research News

5 Aug

Why is the long term bond gauge unhappy?

Of late we have seen a very attractive set of conditions for bonds, as reflected in the daily gauge. The weekly index however has been drifting lower primarily due to the influence of utility stocks which are included only in that longer term index.

How weak are they?

Utlility fear1

As you can see they have faded while the S&P is still very close to its record highs. This chart also lets you see the relationship between bonds and utilities. It is generally very solid bu there are certainly times when the two diverge (such as October 2015).

We can filter performance based on whether utilities are rising (vs the close of 5 days ago):

Bond perf w Util filter

What a difference! Over the period bonds (10 year note futures) rallied 82 points and if you used this filter you made 84 points. If you did the converse you lost 1 point. This will be hard to beat.

Current Conditions

Today the short term gauge is at 100 so we need to ask – What if utilities are falling but the short term index is very bullish?

Utitity blog1

Having both things in our favor yielded a 31 point gain while having only the short term gauge (STFG) with us made only 8 points. These figures are smaller because there are fewer events in both cases than when we have just one condition as in the second chart. If we look into this a little closer we see that in the ’08-’09 mess, utility stocks fell with the stock market so we were prevented from buying bonds during the rally (in case 2). That is not the nature of our problem today. We have a more conventional situation. Stocks are rising and utilities are not because they are not favored if prosperity leads to inflation or Fed tightening.

A Combined Index
We can normalize utility stock momentum so it moves between 0 and 100 just like the bond gauge. Then we can average the two and see where we stand.

Utils Blog2

That combination is now around 50 and we can see what that means but let’s first look at how good this index is at forecasting return:

Utils Blog3

The advantage is significant but if we look at returns when this index resides in a region between (say) 40 and 60 we make almost no money for the entire 11 year period when bonds were rallying.

Conclusion
When utilities are sick we must be wary of bonds. Short term buy signals must have tight(er) stops.

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