Bonds Up, Stocks Down – The Sinister Truth Behind March’s “Portfolio Rotation”

A cheesy Western standoff often begins with some variation of, “This town ain’t big enough for the both of us.”

That’s where we are now with stocks and bonds. And we’re approaching the point where the town ain’t big enough for either of them.

The Treasury continues to pound the market with massive amounts of new supply. But Treasuries held their own this month. In fact, they rallied a bit.

Instead, stocks got their turn in the barrel. This illustrates the point I have been making that there’s no longer enough liquidity in the system to support bull moves in both stocks and bonds. If one rallies, the other must be the source of funds for that rally. So in March, stocks were the liquidity sink that supported the rally in bonds.

And don’t be fooled by Thursday’s rallies in both stocks and bonds: neither baseball, life or financial markets move in a straight line. They are full of surprises. But there’s always a broader arc that contains these surprise days. Our job is to identify the direction of that arc. And in this case the forces of that broad arc are pointing down.  

Here’s what the “stocks vs. bonds” standoff is telling us about the incipient bear market – and my recommendations for what to do

I Predicted This Slide Back in February – And We’re Right on Target So Far

I’m not one to toot my own horn, but I do just want to observe that so far, the bear market that I believe began in January is proceeding right on schedule.

I pointed out in early February in the Wall Street Examiner Pro Trader that stock prices had inflated by an astonishing 24.9% over the 12 months ended January 17, leading to an all-time record overbought reading on the CLI (Composite Liquidity Indicator). That upside extension even exceeded the degree to which the market was oversold versus liquidity at the February 2016 bottom. We therefore knew then that the market was in an extreme buying panic – a mania – from September through most of January. I said then, “That leaves a lot of room for a decline.” 

And as it turns out, I was right.

The early February market break was the start of it and we are probably now in the second phase of that decline and in the very earliest stages of the first leg of a major bear market. The inflation rate of stocks has already dropped from that shocking 24.9% in mid-January to just 10.4% annual change in the week ended March 23.  I expect the 12 month rate of change to turn negative later in the year.

As I wrote in early February, “The level of overextension of stock prices from the liquidity trend reflects an extreme degree of risk of rapid deflation of the stock market bubble.” That overextension has barely begun to be corrected. The risks remain high.

Let’s take a look at my secret weapon, the CLI, and see what it’s telling us about our next steps.

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