Hey There Income Hunter,
We have a major battle brewing between Tech (QQQ) and Bonds (TLT).
Over the past year, these two have stood toe to toe …
Most of the time TLT would lead the Qs up or down, but they were always neck-and-neck, trading very tight together.
Just two weeks ago they were both down 30%, but as of yesterday TLT came in -36% while Qs are down 26%.
That is a sizable divergence and provides some insight for a high probability trade – including one I just put on.
Comparisons across asset classes, like bonds and stocks, can lead to good low-risk/high-reward trades.
Notice in the chart below that lower TLT prices (black line), led QQQs down over the past year as they traded within a tight range …
Each time QQQ would sprint ahead, mostly during short covering rallies, lower TLT prices would pressure QQQ valuation and they would roll over and continue down.
The reason they are tightly correlated is because the interest rate on bonds is used in the calculation for growth stocks, which covers most tech stocks.
Growth stocks use a present value calculation based on a long-term interest rate assumption and – therein lies the connection between the two.
So, when you get a divergence as large as what we are seeing right now, there are opportunities for high-probability trades.
Who Is Leading & Who Is Following?
It is pretty clear in the chart above that each time the QQQs rallied, TLT stayed within its downtrend and QQQs reversed.
Could this time be different?
I don’t think so, and I’ll tell you why …
The chart above shows us that growth stocks are overvalued vs bonds …
Now, next week I think the Fed will hike rates .75%, and may address concerns of liquidity in the bond market and how they will counter that …
We could then see an extended rally in TLT – but it may not do much for QQQ as economic growth continues to weaken through November and December.
Bring It Home
We are at a major inflection point in the markets. Just look at a few of yesterday’s headlines …
- Bank of Canada (BoC) follows the Reserve Bank of Australia (RBA) in reducing their rate hikes .25%
- China’s Yuan soars the most in history after Beijing orders banks to dump US dollars
- Traders urge ECB to ease collateral shortage in repo market (as credit freezes up)
- Home prices plunged the most since 2009
The central banks can no longer ignore the damage being done to the markets and the economy.
We may be turning the corner on the tightening cycle because the Fed needs to surrender the dollar, which will provide liquidity for foreign countries and for the bond market.
I got out ahead of the change in the Fed narrative and booked some profits on my VanEck Gold Miners ETF (Ticker: GDX) call spread yesterday.
I am looking to book profits on my United States Natural Gas Fund, LP (Ticker: UNG) call spread today and on my put butterfly spreads in SPY and QQQs.
Stay tuned, as we will be getting much more information before next week’s Fed meeting. Until then …
Live and Trade With Passion My Friends,
Griff