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What Does The Bond Market Know That The Stock Market Doesn't?

By Michael KramerMarket OverviewMay 08, 2020 10:30AM ET
www.investing.com/analysis/what-does-the-bond-market-know-that-the-stock-market-doesnt-200524014
What Does The Bond Market Know That The Stock Market Doesn't?
By Michael Kramer   |  May 08, 2020 10:30AM ET
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This article was written exclusively for Investing.com

Stocks and bonds are diverging, with equities rising and bonds trading sideways. Both asset classes appear to be telling a different story. The rising stock market tells a story of hope, while the bond market seems to be in despair. If the bond market proves to be a better indicator of the economic outlook, then the stock market may be in for a harsh reality.

Since March 23, the US 10-year Treasury rate has been hovering around 60 to 70 basis points and is going nowhere fast. The record-low interest-rates would suggest the economic outlook is not likely to improve for the US anytime soon. Meanwhile, the S&P 500 has risen by roughly 28.5% from the lows, suggesting perhaps the worries of the coronavirus may be behind us.

SPX vs UST 10Y Daily
SPX vs UST 10Y Daily

Low Rates Are A Bad Sign

Typically, one would think that low-interest rates would be positive for stocks. But in this case, the low rates suggest the economy is not likely to see a meaningful acceleration any time soon. Even 5-year breakeven inflation rates have tumbled. Which all suggests a sluggish economic recovery, and that is not particularly good for the stock market over the longer-term.

During the steep February and March sell-off, inflation expectations fell along with the S&P 500. However, on April 15, inflation expectations fell sharply, while stocks continued to rise. The change in trend seems to suggest that the economic outlook for both markets took different paths.

5Y Inflation Rate vs SPX
5Y Inflation Rate vs SPX

Weak Economic Recovery?

With inflation expectations falling, it suggests that economic output is likely to be weak. With weak growth and low inflation, there is no reason for bond yields to rise. If that is the case, then one must wonder what it is the equity market is thinking about at the moment.

If rates did begin to rise, then it would validate the equity markets' sudden surge and indicate an economic recovery is taking shape. While typically rising interest rates can be seen as a negative for stocks, that is not the case at the moment.  The Federal Reserve has also made it pretty clear it will not tighten monetary policy anytime in the near future. It means that rising inflation and interest rates will not pose a threat to stocks at this point.

Two Tales?

The divergence between stocks and bonds may be telling a tale of two markets with two very different viewpoints. One that suggests economic growth and inflation are likely to remain subdued for some time to come. If this is the case, then it seems to be only a matter of time before the stock market itself realizes the adverse effects of the economic slowdown, and the recovery is not taking hold as planned.

In either case, there seems to be a clear separation taking place between the markets, and it seems more likely that the bond market is looking for a slow economic resurgence, while stocks are still looking for that elusive "V" shaped recovery.

Whatever shape the recovery ultimately ends up taking will only be known in hindsight. For now, what it really comes down to, is which market you believe more, and which market will ultimately be right. Bonds or stocks?

What Does The Bond Market Know That The Stock Market Doesn't?
 

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What Does The Bond Market Know That The Stock Market Doesn't?

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Comments (34)
Pramukh Investments
Pramukh Investments May 09, 2020 10:39PM ET
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We are pricing 18 months out. No one cares how bad this year will be. There is a FED PUT and massive stimulus driven spending power created to offset the ****** S and P going back to 3K
Casino Crypt
CasinoCrypt May 09, 2020 9:52PM ET
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No brainer. Bonds are very transparent indicators as they track raw risk. Raw risk is when you simply walk down the street and see shuttered up commercial buildings. The world is a book . Walk around and you see things. Translate that into investments and you see property bleeding money .  Hope is an equity investors Grim Reaper.
Terence Williams
Terence Williams May 09, 2020 4:36PM ET
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Bonds..We buy more of them than China..the US government. We create our own paper and sell it to ourselves. Bonds or yields are well aware of the supply chain coming soon in greater numbers. It's a game of course..one where all know the rules, and are perfectly complicit to play the game..because the alternative is disaster for all of us. Stocks crashing..those that wish for that better be thinking of becoming preppers..you know..stocking up on food ,guns, and gold. I don't know if my thoughts have merit on introspection..but I know there is some hard truth .
James Holmgren
James Holmgren May 09, 2020 3:34PM ET
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Can anyone explain how negative interest are going to work as some are expecting negative rates next year? For example will China buy our bonds then pay us a % while they hold them?
Mehdi Ariya
Mehdi Ariya May 09, 2020 12:48PM ET
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Intrereting analysis. I prefer to wait too. Soon or later the stock market bubble will be burst.
Anthony Fernandes
Anthony Fernandes May 09, 2020 12:33PM ET
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SEC put money in stocks no in Bonds for me that make sentences
Anna Phillips
Anna Phillips May 09, 2020 10:03AM ET
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I think that people are buying stocks with their stimulus checks short term for quick profit and on news flashes. But checks will run out reality step it major sell off! I prefer wait
Adam Stevens
Adam Stevens May 09, 2020 1:29AM ET
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Tells me the $SPY is going to 185.
Gregory Zwick
Gregory Zwick May 08, 2020 9:00PM ET
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Could it be that those thinking inflation is years away have it wrong?  Suppose as the equity market bulls are saying, this is a V-Shaped recovery.  Suppose demand for everything comes roaring back.  Now, loaded with stimulus checks, cheap loans and abundant money, demand is far greater than it was pre virus with more money than ever to throw around. The supply chain has beed disrupted and is no longer able to handle the shifts brought about by the pandemic.  What people will demand  and how it can safely be produced and delivered will add to costs and create many shortages. Inflation is coming. Few can see it or will believe it, but they will all be willing to pay more to get it.
Jáchym Vaněček
Jáchym Vaněček May 08, 2020 9:00PM ET
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Thank you Gregory for your insight.
Jeremy Williams
Jeremy Williams May 08, 2020 9:00PM ET
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You mean the checks that most people havent received yet?
Don Getty
Don Getty May 08, 2020 9:00PM ET
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1200$ isn't going to go far after you've paid your rent or mortgage
Alan Rice
Alan Rice May 08, 2020 7:36PM ET
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And the bond markets don't know "The Wolf".
 
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