The number one rule many of us were taught is “Don’t Fight the Fed.” I like to add “trend” into that equation and, as you’ll see in the next chart, the math is compelling.
When the Fed raises rates (don’t fight them) and the trend turns negative, equities underperform. Focus on the red arrows. Two different time periods are measured, however, the message is the same. The big corrections come when both the Fed and trend turn negative. I wrote some time ago in On My Radar to “watch out for minus 2.” We currently sit at -1. I’ll share this chart from time to time – especially if -2 is triggered.
Here is how you read the chart:
- The top section plots the S&P 500 Index but focus on the middle section.
- NDR has a Multi-Cap Tape Composite Model to measure the technical health of the broad equity market. That model aggregates the signals of over 100 component indicators and generates a signal based on the percentage of the component indicators that are giving a bullish signal for the S&P 500. It measures momentum and trend.
- The Fed component is really an interest rate component, which measures the trend in rates by looking at the yield on the 10-year Treasury note. When the 10-week trend in yields are lower than their 70-week trend in yields, the S&P 500 has produced larger gains. When it is higher, the S&P 500 has performed poorly. It’s that simple.
- The combined indicator can produce a score of -2 (both indicators are bearish) to +2 (both bullish) and overall have done a good job historically as a risk-on/risk-off indicator.
- The current reading is -1 (data shows we need to watch out for -2): refer to the red arrows.
Source: Ned Davis Research