People like to “understand” things. I guess it’s only human nature. And especially if we are going to invest our hard earned money, then we really want to have some understanding of what it is we are getting into and why we have some realistic expectation that it should work.
And it all sounds exactly right. In theory.
The famous old adage is that “Knowledge is Power.” And this is true, ironically, everywhere except in the financial markets. This leads us directly to:
Jay’s Trading Maxim #112: In the financial markets, too much knowledge can be a dangerous thing – especially if it is the direct result of too much thinking.
Japanese Stocks versus T-Bonds
For some reason the price action of t-bonds and Japanese stocks have long experienced an “inverse” relationship. To put it into “highly technical” terms, when Japanese stocks “zig” t-bonds tend to “zag” and vice versa. (I warned you it was highly technical).
Now I am certain that there is a perfectly good explanation for this typically inverse relationship. Unfortunately I personally have no idea of what it might be. In all candor there is a part of me that is itching to make up some BS explanation about how it is all related to relative economic growth, exchange rates, Fed policy and the price of tea in China.
But as a proud graduate of “The School of Whatever Works” I personally don’t actually care all that much about “why” this is the case, only “how consistently” this is the case. Based on what I have seen (to my way of thinking) the answer is “consistently enough.”
Figure 1 displays two charts. On top is the spot price for T-Bonds and on the bottom is ticker EWJ – an exchange traded fund that tracks the MSCI Japan Index.
Figure 1 – US T-Bonds (top) versus Japanese Stocks (ticker EWJ)
What we find is that T-Bonds tend to perform better when the 5-week moving average for ticker EWJ is below the 30-week moving average. And vice versa. So just how well does a 5-week and 30-week crossover work? Figure 2 displays two equity curve lines starting in September 1997.
-The blue line displays the growth achieved by holding a long position of one t-bond futures contract only on those days when the EWJ 5-week moving average is below the EWJ 30-week moving average.
-The red line displays the growth achieved by holding a long position of one t-bond futures contract only on those days when the EWJ 5-week moving average is above the EWJ 30-week moving average.
For the record:
-A long position held in t-bond futures when the EWJ 5-week average was below the EWJ 30-week average gained over $81,600
-A long position held in t-bond futures when the EWJ 5-week average was above the EWJ 30-week average lost over $36,092.
The last crossover was the EWJ 5-week average moving above the EWJ 30-week moving average on 11/30/2012. Since that time t-bond futures have fallen 21 points (or $21,000 per contract). Ticker TLT – the exchange traded fund that tracks the long t-bond has fallen -17.5% since that time. Ticker TBT – ProShares Ultra Short 20+ Yr. Treasury ETF has advanced +33%.
So why are Japanese stocks and U.S. t-bonds typically inversely correlated? Excellent question! My frank advice is to try asking Google. In the meantime simply note that the EWJ 5-week moving average is presently remains above the 30-week moving average (in case the whole “inverse” thing is confusing you, this is still bearish for t-bonds).
However, the gap between the 5-week and 30-week average is at its narrowest point since it crossed over to bearish territory back in November of 2012. If Japanese stocks exhibit more weakness in the near-term we might see the EWJ 5-week average drop below the EWJ 30-week 5-week average in the not too distant future.
Given that t-bonds are extremely oversold and that the “consensus” seems to be that interest rates are “destined to rise” (thus implying that bond prices will fall), from a contrarian point of view, the EWJ 5-week and 30-week moving averages are something you might want to keep an eye on.