From the "Are You Kidding Me?" Department

In looking at the pre-market news early on Monday morning (around 8:30 a.m.) I came across this blurb:

"S&P futures vs fair value: +2.3. Nasdaq futures vs fair value: +4.5. Versus fair value, futures trade suggests an upside open for the cash market. Worries over consumer spending have been somewhat allayed this morning, as the National Retail Federation has reported a strong start to holiday sales. Weekend sales surged 22% over last year, with discount, electronics, and home-furnishing retailers faring best. In addition, crude's continued decline underpins the bullish bias. The commodity is currently 1.8% lower ($57.66 per barrel)."

A few moments later this came out:

"S&P futures vs fair value: +2.1. Nasdaq futures vs fair value: +4.0. The cash market remains poised to open higher. Due in part to solid sales over the weekend, Wal-Mart (WMT) announced this morning that November same-stores sales will rise 4.3%."

So, all is well for investors, right? Especially the retail stocks? Not even close! Quite frankly, we've seen this too many times before to take the bait. The media cites the cause-and-effect, setting up what is supposed to work out.....at least that particular day. Well, as most of you know, I'm very skeptical of anything that seems too obvious, and I'm especially skeptical when the media tends to be overly certain about anything. That's why I just shook my head at those early headlines. They never even acknowledged that any retail-sales-based strength may already be built into current prices. (They also overlooked the fact that that the 'effect' usually happens before the 'cause'.)

By the end of the session, stocks were deep in the red, and the retailers were leading the bearish charge. This excerpt came from an AP story published later in the day:

"Wall Street took a break from its five-week rally Monday, with stocks declining moderately as investors weighed....a mixed picture on last weekend's start to the holiday shopping season.....while some of the nation's retailers reported a solid opening to the crucial holiday sales period, other merchants said shopper traffic tailed off once Friday's bargains passed. Retail stocks sank despite Wal-Mart Stores Inc. and J.C. Penney Co. posting better-than-expected numbers."

The retailers, and department stores in particular, were hammered yesterday. Am I surprised about the turnaround? Not at all. This retail-related disparity one that you can almost set your clock by around this time of year. The point is, while you can believe all the data you hear from reputable sources, never assume that their forecasted effect is the right one. There was a lot more going on in the retail world than the National Retail Federation's alleged sales 22% increase data, as we all found out when these stocks took a big hit. Maybe retailers will recover, and maybe not. All I know is that anybody buying that particular news got hurt.

A Better Picture of the Yield Curve

We got this question several days ago, and have been waiting for a chance to answer it. We just think it's something everybody would benefit from seeing.

QUESTION: Much discussion has been made about the flatness of the yield curve. We currently see the 2-30yr spread is less than 0.4 %. Can you provide some typical spreads we should expect to see during normal, healthy economic times for 2-10, 2-30, and 10-30 spreads?  What is considered normal? Two to three percent difference in the 10 to 30 years?

[Editor's note: This is a fantastic question, as nobody (that we're aware of anyway) has ever really defined how much curve should actually be seen on a 'normal' yield curve. I think the best answer is 'it depends'. Nonetheless, there has to be some sort of systematic way of determining whether the yield curve is healthy or not, so the reader's point is well taken. Here we go......]

ANSWER: First and foremost, we're market technicians. In fact, we're economists least of all. But we'd be crazy to ignore the yield curve, in that it still has an effect on what we do here on a daily basis. So in that regard, we're as interested in an answer as anyone else is. The question is, how does a technical analyst view data that is clearly economic in nature? To be honest, I think the unbiased, unopinionated view that we have may be an even better take on the flattening yield curve than the one that the pure economists have; we see the data for what it is, and it's affect on stocks. Nothing more, nothing less.

So to answer the question, we did just that - we put together all the historical data.

Along the way, we also realized one inherent problem with the way the yield curve is usually displayed - it's static. In other words, it only gives you a snapshot of what the curve looks like today. Well, like the reader, we're equally interested in how the yield curve is changing shape over time. So instead of the typical 'short-term to long-term, left-to-right' picture you so often see, we're going to plot the yields of three separate instruments over the course of the last couple of decades. This makes it much easier to compare what's going on now with what was going on then.

Instead of the 2-year and 30-year treasury yields, we used the 1-year (blue) and 30-year (red) yields. We also added in the 5-year yield (gray) for the sake of comparison. As you can see, short-term yields are quickly approaching longer-term rates. And as you can also see, this isn't particularly good for the market. The last few times the yield curve became inverted - or even close to inverted - stocks took a hit. See the areas highlighted in yellow? Sometimes it was only a minor blip, but in 2000, it was a major problem. That's why the folks who are worried now have a legitimate concern. And just for the record, we're equally worried about the longer-term effects an inverted yield curve could have. (continued after chart)

S&P 500 versus Interest rates (Yields) an 1, 5, and 30 year Treasuries

To answer the reader's question, here's what we found out about historical norms of the yield curve. Since 1990, the average 1-year T-Bill yield has been 4.13%, the average 5-year T-Bond yield has been 4.33%, while the yield on the 30-year Treasury has been 6.23%. That means the spread between the 1-year and the 30-year should be (assuming the average is 'normal') a little better than 2%. The 5-year shouldn't be a whole lot higher than the 1-year....say 0.2%. The 10-year yields (not shown) were usually just a fraction under the 30-year yields, so there's nothing significant or unique that we missed by not using that data. Anyway, that's the good, bad, and ugly on historical yields.

Is the methodology perfect? Nah - there's never a true 'apples to apples' scenario. Plus, maybe the last 10 years were statistically unusual. Ideally, we'd go back in time to where the data started being recorded. We just had to draw a line somewhere. But still, we think this chart should help a lot of you figure out the yield curve trend, which is much more important than the yield curve at any one single point in time.

Price Headley is the founder and chief analyst of BigTrends.com.