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Stocks / Bonds, Moving Together Are Sign of Market Trouble

By Frank McGuire   |

The changing relationship between bonds and stocks may be a sign of trouble ahead, The Wall Street Journal warns.

Difficult way

Concept of crisis with difficult long way

“A generation of traders have grown up with the idea that stock prices and bond yields tend to rise and fall together, as what is good for stocks is bad for bonds (pushing the price down and yield up), and vice versa,” the Journal explained.

“This summer, the relationship seems to have broken down in the U.S. Share prices and bond yields moved in the same direction in just 11 of the past 30 trading days, close to the lowest since the start of 2007,” the Journal reported.

Since Lehman Brothers failed in 2008, such a swing in the relationship has been unusual and suggests prices are being driven by something other than the balance of hope and fear about the economy, the Journal reported. Such a trend has tended to coincide with times of deep discontent in markets, notably the 2013 “taper tantrum,” when bond yields briefly surged after Federal Reserve officials signaled they would soon end stimulus.

“The simplest explanation is that expectations of interest rates being lower for longer—some central bankers have suggested lower forever—pushes the price of everything up, and yields down. When the focus is on the discount rate used to value all assets, bond and stock prices rise and fall together, creating the inverse relationship between bond yields and shares,” the Journal said.

“There is an alternative explanation for the breakdown in the U.S. equity-bond correlations. It could be that shares are tracking improving economic developments, while Treasurys are being driven by British, Japanese and European money fleeing super-easy monetary policy,” the Journal explained.

“It could be that this summer’s price moves were just noise while traders were on the beach, and stock prices and bond yields will start moving together again soon. But keep an eye on those correlations, as shifts often mean tough times ahead for investors,” the Journal warned.

Regardless, not all experts are as pessimistic about the market’s near-term future.

“We think the US stock market is going higher,” Morgan Stanley’s Adam Parker said, according to Yahoo Finance.

“We are raising our 12-month price targets for the S&P 500 – base case from 2200 to 2300, bear case from 1600 to 1800, and our bull case from 2400 to 2500,” Parker said.

The US stock market continues to defy the odds, with the S&P 500 rallying for seven and a half years in what has been one of the most impressive bull markets in history. At 2,179 as of Friday’s close, the S&P is up 227% from its March 2009 low.

Parker also reiterated his forecast that the S&P 500 heads to 3,000 by 2020.

“We still believe this to be true, as most US consumer metrics appear directionally positive (housing, jobs, delinquencies, obligations, confidence, personal spending, etc.); corporate excess seems under control; and low growth is still the base case economic forecast,” Parker said.

“With few other attractive investment alternatives, we see the US equity market as the beneficiary of further appreciation.”

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