The business cycle, stock prices, and bond yields

In the good old days, when the markets did what they were supposed to do, without macro distortions, this is what it used to happen.

Why am I saying this? Because my instinct is telling me the markets are beginning to reassert themselves and the old relations between market data are going to appear again.

Some definitions first.

The stock market is a leading indicator of the business cycle. Translation: every recession has been anticipated by a peak in stock prices.

Bond yields are a lagging indicator because they bottom after the trough of the business cycle.

OK, why should I care? Because the relations between a leading and lagging indicators may come back and be a useful investment tool, as it has always been in the past.

This is the relationship between a leading and lagging indicator.

1. A bottom in the leading indicator is followed by a bottom in the lagging indicator.
2. A bottom in the lagging indicator is followed by a peak in the leading indicator.
3. A peak in the leading indicator is followed by a peak in the lagging indicator.
4. A peak in the lagging indicator is followed by a bottom in the leading indicators.

Let's translate the above to today's action.

• Yields have soared
• They will be followed by a peak in the stock market
• A peak in the stock market will be followed by lower yields.

One more concept. The sharper the rise of the lagging indicator the more pronounced is the decline of the leading indicator. This is a historical truism. 

According to the above theory the recent sharp rise in yields will be followed by a sharp decline in stocks. Eventually the decline in stocks will be followed by a decline in yields. And the cycle continues.

It remains to be seen if this relationship is going to be valid in the following months. As I said, it is just a theory and time will tell if things will happen as they happened in the past.

Stay tuned.

You will find more details on how these ideas apply to portfolio management in The Peter Dag Portfolio on www.peterdag.com
 
George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977 Author, Profiting in Bull and Bear Markets
No. 1 bond timer in the past 12 months. 

Disclaimer. The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.
STRATEGIC INVESTING FOR UNCERTAIN TIMES. Learn how to manage your portfolio risk and sleep comfortably. Improve the certainty of returns by taking advantage of business cycle trends. Learn to use simple hedging strategies to minimize the volatility of your portfolio and protect it from downside losses.