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A mixed Message Sent by Stocks and Bonds

David Becker
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A mixed Message Sent by Stocks and Bonds

The bond markets does not believe there is any growth on the horizon and that inflation will remain subdued for years to come. Bond yields have broken down through trend line support and could be targeting the lows seen during the financial crisis. This comes despite a stronger than expected PPI report released on Wednesday and traders are unlikely to let a stronger than expected CPI (scheduled to be released Thursday at 8:30 ET) influence their positions.

The 10-Year Treasury Note Yield fell below its early February low on Wednesday. That puts the TNX at the lowest level since last October. That seems strange considering that the Dow and S&P 500 have just hit record highs. Many would expected 10-year yields to be closer to 3%. The discrepancy between falling bond yields and rising stock prices are just another sign that the recent large cap rally may not be as strong as it appears. The downturn in bond yields in January coincided with a pullback in stock prices. Both then stabilized at the start of February. Since the start of April, however, falling bond yields have diverged from a rising SPX. Wednesday’s breakdown in bond yields makes their divergence even more striking. One of the two markets is sending the wrong message. The question is which one.

chart-mixed-message-sent-stocks-bonds.png

High yield corporate bonds are more closely tied to stocks than bonds. When stocks are strong, high yield corporates do better than Treasury bonds. That’s especially true if bond yields are rising. When bond yields start to fall, fixed income investors favor longer Treasury bond maturities. Relative weakness in high yield bonds is often a warning of weaker stock prices. Higher yield bonds have been trailing both stocks and bonds and have been caught in the middle which is another odd sign sent by the market.

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