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

Published 05/08/2020, 10:30 AM
Updated 09/20/2023, 06:34 AM

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

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

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?

Latest comments

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
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.
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 .
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?
Intrereting analysis. I prefer to wait too. Soon or later the stock market bubble will be burst.
SEC put money in stocks no in Bonds for me that make sentences
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
Tells me the $SPY is going to 185.
Could it be that those thinking inflation is years away have it wrong?  Suppose as the equity market bulls are saying, this is a V-Shaped recovery.  Suppose demand for everything comes roaring back.  Now, loaded with stimulus checks, cheap loans and abundant money, demand is far greater than it was pre virus with more money than ever to throw around. The supply chain has beed disrupted and is no longer able to handle the shifts brought about by the pandemic.  What people will demand  and how it can safely be produced and delivered will add to costs and create many shortages. Inflation is coming. Few can see it or will believe it, but they will all be willing to pay more to get it.
Thank you Gregory for your insight.
You mean the checks that most people havent received yet?
1200$ isn't going to go far after you've paid your rent or mortgage
And the bond markets don't know "The Wolf".
The stock markets don't know who Peter IS. -Rice
You're one of the bears in the miniscule fraction of the AAII bull/bear ratio (lowest since 2009 IMO) which I believe is a contrarian indicator . It appears the institutions are supporting this SPY rally according to Tom McClellan and less and less participation - also contrarian indicator. Market Internals are positive. Not financial advice for readers.
One of the best articles I've read in a long time, very informative and comments are surprisingly very good as well. Good article equals good comments.  As far as market, will it go down? As long as fed pumps, I have serious doubts.
Guys, whats your watchlist looks like for the next week?
I'm great at buying high and selling low
I don't just buy high sell low, I always short from bottom
trick is never sell. you have to remember the reason you bought in the first place
Don't forget the Fed buys half the bond market, so it is not a normal market. Im actually bearish but I don't think you can accept bond market signals anymore.
very true
Central banks r zero or negative. Nothing to read. Move on.
Looking to make sense of this market through PE’s and comparisons to the bond markets in this market is like looking for water with a bent stick. PE’s are meaningless the 5 tech stocks drive the fortunes of all global markets in the world through a system of derivitives and swaps, Apple, Microsoft, FB, Amazon and Netflix and a few secondary tech stocks are all that matter. Bet on them going up and you will win, place your bet anywhere else and you will lose.
For a short while longer this will hold true.  The downward revisions started 3 weeks before these companies missed or barely met their reduced EPS estimates.  The downward revisions will continue.  See the story today from Bank of America on the money flows from big investors and hold onto that bag tightly.
If anyone is interested search for: Investors exit stocks at fastest rate since March, 'tech fatigue' sets in: BOFA
Basically, lower interest rates aids higher P/E. So, stocks that attract higher P/E are the ones climbing faster while the rest are just following the momentum
Aren't Bond Markets a good indicator of LONG TERM Growth? Whereas the Stock Market is more reactionary and SHORT TERM (Q1/Q2/Q3/Q4)? The outlook for bonds are correct, mainly because their outlook spans many years. The stock market outlook is also correct, because what matters most to "investors" is QoverQ growth. Its possible the previous selloff in stocks was an overreaction (as is the norm in that field) and the current "rally" is just a levelling off. instead of a "V" shaped recovery in the stock market, I personally believe we will see a "Square Root" recovery, meaning a sharp selloff, a bounce back, then primarily sideways trading for the near future. I hope my opinion proves insightful. Thank you for the well written article.
Most of the stock market has it right.  The Robinhood crowd has been coerced into the belief that a few big tech companies are somehow immune to 35,000,000 consumers being unemployed in a consumer driven economy.  Earnings were revised down a couple of times for most of these companies and even then some missed on eps but it kept the bubble inflated.  When it becomes apparent that even tech needs a healthy economy to provide the E in P/E ratios it will be too late for these merry men.  Someone mentioned the 2000 dot-com bubble.  I agree.  These forward P/E ratios of 30 to 50 will ultimately correct and do it rapidly.
Thanks a lot Michael for the thought provoking article. But is it really telling a different story or is the large increase in liquidity/money supply/QE holding interest rates down and therefore bond yields low. The tech stocks carrying the market for now...
Markets always go up before they go down: Look at 2015 July before 2015 August 24th, 2016 June end before July dump, 2019 Sep until 2020 Feb (that was a biggey) .. you get the point. So, Sell in May and go away .. ?
So are you saying that one shouldn't buy stocks for a 1y period this month? Because I thought this crisis is an opportunity.
Right now it's a temporary opportunity, Dazzy. The bond market is indicating that there will be another down leg in the stock market. After that, that will be the longer-term opportunity that you're referring to. This current uptrend is not based on fundamentals, but rather "hope" and huge injections by the Fed. That's why it won't last.
Great article, i just joined investing in 2019, now even in indonesia is the same while the recession are coming in june but the market are still rising high
The graph is showing that the stock market is rallying but at the same time the bond market is going down
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