The recent rise in the budget deficit and the ongoing fear that the Fed will continue their tightening ways is providing a solid headwind to all the stock buy-backs (due to the corporate tax cuts). If nothing else it’s a recipe for a turbulence. This chart shows how the situation compares to the S&P breakdown from early this year. We have a very similar dynamic:
The key observation is at the bottom – when the 10-yr bond price is rising (above a quarter of a 20-day std. dev.) then stocks do better (over the last 4 years). When they are falling you make nothing by shorting it OR buying it (2nd plot, blue line) There is no direction at all that can dominate with bonds doing badly. That 800 point gain equals the entire upside for the period.
Most importantly we need to avoid periods like we are in today – we can wait for stability. At some point, a weaker S&P will stabilize bonds – if it doesn’t then we must bail out. (The bond test is done the day before the S&P trade.)
The next question is how much of a Vix jump do I need to prospectively get over further rate rises. There are (as always) many moving parts. As rates go up to scarier levels we’ll need ever more fear. We’ll need lots of departed buyers who will be getting involved. Thus the baseline Vix range will rise and get sticky. Many will wonder when we’ll get back to the lower levels we had gotten used to.