Update on the 10-year/30-Year T-Bond Spread

Earlier I wrote, “the S&P 500 hasn’t shown any net capital gain whenever the 10-year/30-year spread is wider than 43 basis points.”
That’s correct, however, I looked into the numbers a little more and it seems that the recent financial crisis had an unusual impact on this data series.
In my mind, a positive spread ought to have a positive impact on equity prices. I found that if I take out the period from October 2007 to March 9, 2009—yeah, I know, that’s a very big if—then numbers start to make more sense. Suddenly, a positive 10/30 spread is good for stocks.
After taking out that awful 17-month stretch, here’s what I found. Stocks do well whenever the 10/30 spread is greater than -33 basis points (that’s about 95% of the time). Stocks do especially well when the spread is greater than 11 basis points which is about 63% of the time. A spread of more than 11 points translates to an annualized gain of 15.6% (not including dividends). When the spread is less than 11 basis points, the annualized gain is just 1%. To reiterate, we’re now at the highest spread ever.
So is what I’m doing kosher? Errr…it’s hard to say. I can be accused of data-mining because that’s exactly what I’m doing. However, as an analyst, we have to look at our data in context. When the world was falling apart, the numbers started to make very little sense. It’s almost like putting a magnet near a compass—all the readings go kablooey.
Ultimately, I think it’s ok to play with numbers like this as long as we understand that we’re looking at models of the market. When things get hot, any historical relationship can and will break down.

Posted by on August 4th, 2010 at 11:53 pm


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