Technical analysis of the stock market has become more mainstream. When I first started in the financial services business it was referred to as voodoo analysis. More and more investors refer to pieces of technical analysis as an accepted science. That said, fundamental analysis is still the most accepted form of research on Wall Street. From my view both are a study in statistical probability using a different set of parameters. Both take faith on behalf of the person using them to put their money at risk based on the statistical calculation which draw a specific conclusion. The key to both is having a disciplined strategy for implementing the process. Without discipline neither will succeed.

With that in mind, today I wanted to look at a chart that has many implications to both sides of the table, interest rates. The yield on the 10 and 30 year bond have been in a decline since the S&P 500 hit a high on April 15th. Why the shift? Primarily the shift in economic outlook combined with fear from the investor seeking shelter from a declining equity market.

As you can see on the chart above (10 year Treasury yield) The decline started several weeks prior to the equity markets moving lower from a peak. Was this an indicator of money moving away from stocks? With hindsight you could say yes, but at the time it was not that clear. As yields broke below the 3.7% level however, you knew something was up. Bonds are a great indicator of fear or perceived problems in stocks relative to a specific event.

There are several points of interest on the chart worthy of learning from. The first was the break below the 3.15% mark. This corresponded with the peak of S&P 500 index hitting 1130 on a bounce off the 1040 low in May. The next two weeks the index fell to 1022 or approximately 10%. The index then rallied back to 1130 again in early August, but the yield on the 10 year Treasury stayed in a narrow trading range only to break lower below the support at 2.88% as the market started its present decline.

As an indicator the yield may not always be right, but it does bare watching relative to investor sentiment. When investors lose confidence in the equity market they shift to safety and that is predominately Treasury bonds.

The chart below is the 30 year Treasury yield and you can see a similar correlation to stocks, but the decline in rates has not been as steep as the 10 year during this cycle. However, in 2008 the drop was more significant to reflect the decline in stocks. The credit crisis took a bigger toll on the long end of the yield curve and the recession has had a bigger impact on the middle of the yield curve. Either way they are worth tracking relative to investor sentiment and in this case benefiting from owning bonds.

The current levels would indicate caution relative to holding bonds. The yields can go lower, but a near term bounce or consolidation would be more likely. That would mean a short term rally in stocks, well worth considering and watching for short term opportunities.

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