‘Sell The Rally’ | Seeking Alpha

The sword of Damocles is already starting to fall on the bulls

On October 9, 2023, I published a serious warning on Seeking Alpha entitled:

“DJIA Trouble Ahead As Thirty-Year T Bond Yield Breaks Above Modified 4.5% Minimum”.

On September 21, 2023, the 30-year T bond yield had moved above 4.5% for the first time since 2011. At 4.57% the daily dividend discount value (DDV) of the DJIA was 36,532, while the price closed at 34,070. The price was 7% below its DDV.

There was no reason to panic and sell the DJIA. However, this was the first time since 2011 that any change in the 30-year T bond has had any impact on the DDV. All the heavy lifting of the DDV until then was entirely due to the rising dividends of the DJIA. Above 4.5% the yield of the 30-year T bond started, once again, to have an impact as the second vector in the DDV model. With the rate rising, it was a negative forcing the DDV lower.

The 30-year T bond yield continued to rise reaching 5.11% on October 19, 2023. The DDV of the DJIA fell to 32,717 while its price fell to 33,414. The next day the price of the DJIA dropped further to 32,717 even though the 30-year T bond yield fell back to 5.08% pushing the DDV back up to 32,948, helped along by a modest increase in the DJIA dividend to a new record level of $724.57.

The empirical evidence of the last four decades confirms that the DDV of the DJIA based on a minimum 30-year T bond yield of 4.5% and its price are closely and causally interrelated with a correlation coefficient of 0.97.

The long-term chart follows:

Over the last four years, the chart below demonstrates the impact on the DDV of the 30-year T bond moving above 4.5%:

The sharp drop in the DDV (the blue line above) is the direct result of the rise of the 30-year T bond yield above the 4.5% minimum as shown below. The rising bond yield is again having a serious, negative, impact in the DDV following a 12 to 15-year hiatus.

Using the near record DJIA dividend of $724.18 as it was on November 3, 2023, the following DDVs can be calculated for a range of different 30-year T bond yields as per the table below:

Click to enlarge

Each basis point move in the 30-year T bond yield impacts the DDV by some 60 points. With a probability of 97%, the price of the DJIA should closely reflect the calculated DDVs.

Similarities to 1987

Some commentators have suggested that the period ahead will be a repeat of Black Monday, 1987. The driving force in both periods was, and is, the increase in the 30-year T bond yield.

In 1987, the yield moved up by 41% from 7.29% in January to 10.25% in October, driving the DDV down by 55% from 2,200 to 1,200 in October.

The price of the DJIA moved in the opposite direction from 2,200 in January to 2,722 in October, up 24%.

In the summer of 1987, I could not understand why the price of the DJIA continued to advance in the face of the DDV being pushed down by the ever-rising 30-year T bond yield. In retrospect, one could think of this being price momentum from the previous 5 years after 16 years of the DJIA going sideways between 600 and 1,000.

At the time I concluded that the price was correct, and my thesis was wrong. Ah! the impatience of youth. I did not repeat that mistake in 1989 when I recommended the sale of the Nikkei at 36,000 and the purchase of the DJIA at 2,481.

This year the 30-year T bond has risen above the minimum 4.5% and the DDV is falling as expected. Furthermore, the price of the DJIA is moving down in tandem with the DDV. So far so good but remember there will be a great deal of daily volatility as the bond market waxes and wanes.

Where do we go from here?

Long-term rates are market-driven and are outside the control of the FED, as Jay Powell stated on October 19, 2023, along with his message that short-term rates could remain higher for longer. Hence, we should not look for any QE to bail out either the bond market or the equity markets. Long rates will adjust to term needs.

Given the rising concerns about U.S. government debt of nearly $34 Trillion and counting, at a time when demand for U.S. Treasuries from Japan, China and even the FED is falling, the outlook for rolling over existing debt does not appear good. Thus, there is a strong likelihood of 30-year T bond yields rising considerably, the DDV falling as rates rise and with it a much lower DJIA price, as per the table above.

Near-term volatility, such as that seen over the past two months, should be expected. The trading mantra should now become, “Sell the Rally”.