Noel
Campbell

Here we are in early April 2003 and there appears no end in sight to the volatility in the markets. By markets, I mean a spectrum from gold, currencies, and stocks to the bonds. Anyone who loves trading should appreciate the opportunities abounding in the markets around the world. Volatility leads to further volatility so make hay while the sun shines, but risk management both in the good times and the bad is more important now than ever. Volatility as you will find can be a double edge sword.

There is a phenomenon taking place in the market right now. When you compare the stock market with the bond market you’ll notice the relationship between the two has changed.

In the first chart here we have the Index (Futures) as the bar chart with a line chart of the 3 Year Bond market overlayed on the same chart. The two regions that I have circled are only a couple of many examples leading up to 2001 where you can see the bonds and the Stock markets moving in unison. The first is the bear market in 1994 and the second the dominant bull market from the 1994 low. I have stuck to the big picture here – on a smaller scale you see the same correlated movements. Essentially, one follows the other.


Chart One

When we take a look in Chart Two which shows more recent market action from 1999 forward we can see that, one follows the other, but there has been a change in the character of that relationship. They still have a relationship between them, but now it’s a case of heading in opposite directions. The low interest rate environment helped drive the bull market of 1990’s and bank stocks led the charge. Now it is a case of when the stocks are in favour, the bonds are out of sorts and vice versa.


Chart Two

Conventional wisdom tells us that the stocks and the bonds markets follow each other. However, in times of extreme uncertainty the bond market represents a safe haven for the bigger investor from the uncertainty in the stock market as they guarantee a return. Markets become extremely volatile around major tops and the departure from the “follow you, follow me” relationship can take place. An example of this was in late 2000 and into early 2001 – basically when the stock market lost the momentum for any new highs of significance. Not to say the run from September 2001 to March 2002 was a highly profitable period for many in stocks.

When looking at the rally in stocks from March 2001 into June 2001 the bonds sold off heavily. From June 2001 until October 2001 the bonds rallied as the stock market dived and that pattern has continued through to the bear market which started in March 2002 for the stocks and to the recent rally for the SPI from the March low. Just like a seesaw.

The long and short of all this is that uncertain times look set to continue. For now the stock market is looking more bullish than it has for over a year and based upon the theory we are looking at here that spells a sell off in the bonds. However should the stock market head south again, we at least from this point of view, get a good sense of where the bond market should head.

The next big test for the Share Price Index will be the 3100 level, which, by the way the market is going, may not take too long to achieve, of course that would need the 7 April top to be broken.

All the best with your trading and analysis,

Noel Campbell

PS – You might recall last week we analysed RIO and the mostly likely scenario seemed down before up. RIO topped on Monday 7 April with a close of $33.26 and since Monday has sold off quite heavily, last trade as I write is $31.67 on Friday afternoon.