Divergence duo

21May07

Divergences are always worth a look. In today’s linkfest we linked to John Hussman’s most recent weekly missive where he looks at the value of the “Fed Model.” Rather than finding that the model worked, Hussman finds it most useful under a certain circumstance:

I discovered a few years ago that the main usefulness of the Fed Model is to identify risks in the bond market – specifically, when stock yields are low but the Fed Model gives a “buy signal” anyway, it is evidence that bond yields are unusually depressed. That signal is typically followed by poor bond market performance (with no reliable implication for stocks).

In that same light, Eddy Elfenbein at Crossing Wall Street graphically illustrates the fact that the stock market has easily outperformed long term Treasury bonds of late.

Bespoke Investment Group compared the performance of the oil & gas sector to the price of crude oil. The oil & gas stocks have been easily outperforming the performance of crude oil of late. They write:

Have investors put in place a higher premium for oil stocks compared to oil prices, or will the ratio revert back to its typical range between five and seven? If you are of the belief that the ratio will revert, oil the commodity has to start outperforming oil-related stocks.

One should remember that divergences can last longer than any one expects. In addition, divergences need not resolve themselves in the most obvious direction. In short the markets have a tendency to fool the crowd at turning points.

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