Some Negative Divergences To Keep Your Eye On

The recent rally in equities has certainly been impressive to say the least. But what interests me is the major divergence developing between equities and bonds. In addition, the general stock market has now decoupled from financial stocks. Together, these negative divergences may indicate that something is not quite right with the market's relentless rally. In fact, it feels a lot like the last melt up back in April 2010, when the market was completely ignoring Greece's imminent collapse. The difference is that the market's rise has been based on QE 2, which it is believed will support higher asset prices.

Below is a chart which compares the 10 Year Treasury with the S&P 500. I have previously showed this chart and commented that one markets is going to be wrong. You cannot have both surging equity markets and rising bond prices indefinitely. Why? Because you buy stocks when the economic outlook is favorable, and you buy bonds when the economic outlook is bleak. You can't have it both ways. Bonds are signaling economic problems while the equity markets are completely drunk on QE 2.

Click charts for larger image.

Below is a chart which compares the XLF (financials) to the S&P 500. You can see that until recently they have moved in perfect unison. Financials are an important sector for the general market as they led us on the way down back in late 2007 and early 2008. They were also the initial leaders off the March 2009 lows, so they are worth keeping your eye on. If financials continue to falter, it is hard to imagine that the market can continue to melt up.     

Black Swan Insights


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