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I see intermarket analysis (the idea that other markets can be predictors of the stock market) mostly as a big waste of time. Often, what correlates today won't correlate a year from now, or the correlation may even reverse. The best way to analyze and forecast stock price trends is to analyze stock prices themselves. That's the basis of technical analysis (TA).
But there is an exception to the rule that intermarket analysis is useless… and it's the U.S. Treasury market.
If you know what to look for, Treasuries – in particular, the 4-week T-Bill – can tell you something very important about liquidity and which direction the money is flowing. That, in turn, will ultimately tell you where the stock market is headed.
Here's how it works.
Before You Look at the T-Bill, Get the Bigger Liquidity Picture…
When I'm not working on TA, I spend the other half of my time analyzing macro liquidity trends, not just as they apply to stock prices, but also as they apply to the U.S. Treasury market. Analyzing Treasury yields and Treasury bill interest rates can be helpful in understanding how the forces of supply and demand affect both the Treasury market and stock prices.
The worldwide pool of liquidity that drives the demand for Treasury securities is the same pool of money that drives stock market demand. We're not looking for a one-to-one correlation that says "If this goes up, that should go up." It doesn't work that way. Sometimes bond yields and stock prices move in the same direction. Sometimes they go in opposite directions. That's why intermarket analysts spend so much time explaining what went wrong or what could go wrong to break the latest correlation.
We do not look first at the bond yields and interest rates. We look at the creation and destruction of liquidity (the fancy word for "money" or "cash"), and then we look at where that liquidity is flowing. Prices and yields are the directional signals.
Liquidity analysis as it applies to the Treasury market helps to establish the context for reading the stock charts. For example, under quantitative easing (QE), stock prices moved up, and bond yields moved down (bond prices higher) with them. That was because the U.S. Federal Reserve was creating so much money that there was more than enough to drive both markets in a bullish direction.
However, if we know that liquidity will be scarcer, and we see that bond yields are falling, then we know that the bulk of the money available for purchasing securities is flowing first to the bond market. When liquidity is tightening, that's bearish for stocks.
We don't have tight liquidity, yet. But we know that we're headed in that direction as the Fed increases the amount of money it pulls from the system under its program of balance sheet "normalization."
We also know that if the Treasury follows the recommendation of the TBAC (the committee of bankers that advises the Treasury on its borrowing needs), the Treasury will pound the market with enormous amounts of new supply over a couple of months. The amount of new supply would be multiples of net new issuance the market normally must absorb. That supply will soak up most available cash, especially when the Fed isn't adding any to the system. Some dealers and big investment firms may also sell stocks to raise the cash needed to absorb the new Treasury supply.
Yields on longer-term Treasuries and interest rates on T-bills should rise as that supply hits the market.
Let's review. We know that when the Fed is adding more liquidity to the system than the Treasury is taking out, then we should read our technical stock price charts with a bullish bias.
When the Fed isn't supporting the market via QE and the Treasury is removing large amounts of cash from the banking system by selling debt, then holding the proceeds, that will affect our analysis in the opposite direction.
That problem will be made worse when the Fed starts withdrawing large amounts of cash from the system. We would normally expect interest rates and bond yields to rise and stock prices to fall. We would give the benefit of the doubt to the bearish interpretation.
That's the environment we are heading into over the next year as the Fed pulls money out of the system. This will be the largest tightening of the supply of money available to fuel stock and bond purchases in the Fed's history.
About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.