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Peculiar Divergences

August 28, 2017 By Jeremy Jones, CFA

What worries me most about the stock market rally are the peculiar divergences we are seeing. What do I mean? Let’s look at some charts. My first chart shows that gold is breaking out to the upside on heavy volume.

SPDR Gold Trust

spdr-gold-trust3

Gold is an inflation hedge, a currency hedge, and a safe-haven asset. When gold rises, other financial assets are often falling. But my stock market chart shows that the S&P 500 has rallied virtually uninterrupted since bottoming in March.

S&P 500

sp-5002

Oddly, though, volume is falling while prices are rising. A divergence in price and volume can indicate an impending reversal. More concerning still is the divergence between stocks and bonds. My chart shows that bond yields (the inverse of price) are falling while stock prices are rising. In a normal economic recovery, bond yields and stock prices rise together.

Stocks vs. 10-Year Treasury Yield

stocks-vs-10-year-treasury-yield2

That’s not the case today. Stocks are discounting a robust V-shaped economic recovery, but the bond market is anticipating anemic growth at best. The divergences between gold and stocks, price and volume, and stocks and bonds may be telling us something about the sustainability of the move in stock prices. With stocks now moderately overpriced on the basis of yield and cyclically adjusted earnings, a defensive investment posture is most prudent.

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Jeremy Jones, CFA
Jeremy Jones, CFA, CFP® is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Richard C. Young & Co., Ltd. was ranked #5 in CNBC's 2021 Financial Advisor Top 100. Jeremy is also a contributing editor of youngresearch.com.
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