Can Yields and Stocks Continue To Rise Together?

Good Morning. Although I'm not a global macro investor, I do think paying attention to the movements in the various markets and asset classes around the globe is a good idea. Wanna know why the market is moving hard without any obvious catalyst? A quick scan of the action in some key equity sectors (banks, tech, energy), the currencies du jour (forget the euro, today it's all about the yen), the foreign markets (think China, Japan, and Europe), the metals (Gold and Dr. Copper generally have something to say), the oil patch, and the bonds (govt's, corporates, and junk) will generally provide you with a clue as to what's driving what.

On Tuesday, some folks may have wondered why stocks charged higher out of the gate after the opening bell. Hadn't all the talk last week been about a correction finally getting underway? Wasn't there worry about Japan going too far, China not going far enough, and then Ben Bernanke's boys starting to do a little something called "the taper?"

It turns out that stock traders were fired up about the comments made by central bankers on other continents while we were busy with the barbeque grill. On Monday, ECB Executive Board member Joerg Asmussen said that the stimulative monetary policy of Europe's Central Bank would stick around as long as necessary. And then on Tuesday in Japan, a BOJ (Bank of Japan) board member said it was vital to keep long- and short-term interest rates stable.

Boom. If you had any questions about the globe's central bankers being the rock stars of the current stock market party, these comments should have erased them. The bottom line here is that while the U.S. Fed may be starting to think about winding down its QE program, other Fed-heads appear to be ready to pick up the slack. As such, the "money sloshing around in the system looking for a home" argument for stocks just might continue.

In response, Chinese stock rallied. Japanese stocks rallied. German, French, Italian, Spanish, and UK stocks rallied - some furiously so. So, it was no surprise that U.S. stocks followed suit. And before you could refill your coffee cup, the DJIA was up 200 points. Booyah, indeed.

However, something else was rallying as well and the move definitely caught my eye. Check out the chart below.

In case you can't make out the title of the chart in the upper left, this is a graph of the yield on the U.S. 10-Year Treasury Note. And since the numbers on the vertical axis are also pretty small, let me say that the yield on the 10-year has "rallied" from 1.631% on May 2nd to 2.135% at yesterday's close. And for those without a functioning HP12C, that's a gain of 0.504% (or 30.9%) in just 17 trading days. Impressive.

A friend and financial advisor who promotes our money management services called to ask yesterday, "What the heck is going on in the bond market. Hadn't Ben Bernanke promised to be "data dependent?" And doesn't that mean that rates should stay low for some time yet?" he inquired. So, while I tend to focus most of my attention on the equity markets, the action in the bond market appeared to be worth a moment or two of my time.

"First and foremost," I assured my friend, "We need to recognize that the economic data has been pretty darn good again lately." I opined that while the bears still seem to assume that the economy will soon encounter the usual summer swoon, Consumer Confidence was reported at a 5-year high on Tuesday and the Case-Shiller Home Price Index rose for the twelfth consecutive month. "Couple this with the better than expected jobs data seen of late and it isn't hard to see why rates might be perking up a bit," I suggested.

Then we started talking about Bernanke's bunch. I reminded my colleague that although the Fed isn't likely to start tapering down the amount of bonds the FOMC is buying every month until September-ish, the point is that this is the next logical step for the Fed. If things go according to plan, "the taper" will be followed by a likely well-publicized hike in rates and then the Fed's "exit" from some of its holdings (i.e. the selling of bonds). It is assumed that such a plan would be accompanied by a meaningful pickup in economic activity. "So, unless the economy takes a turn for the worse, all of the above would argue that interest rates should be rising in the coming year," I added.

This argument made sense to my colleague. However, he was still concerned and came back with a fair question. "Aren't rising rates bad for stock prices? And won't this 'taper' mean an end to the current bull run?" he wanted to know.

Not wanting to keep him on the phone all day, I said as succinctly as I could, "There are three issues here. First, rates have been at generational lows for quite some time and they have been artificially kept down at current levels in order to stimulate the economy. Therefore, if rates rise to more normalized levels, it may not have much of an impact on stocks."

I went on to opine that the second issue at work was the idea that any increase in rates above a certain level would likely occur in lockstep with an improving economy. And if we find ourselves in a rising interest rate environment with an economy that is finally hitting on all cylinders, corporate earnings will likely be growing smartly.

I then proceeded to the big finish. "And then there is the potential for the great rotation," I said. I argued that while there really wasn't any evidence to support the idea of a mass exodus out of bonds and into stocks so far in 2013, I could see how such a rotation could gain traction once rates begin to increase in earnest. I suggested that any manager with a brain will likely want to move from an overweighted position in bonds to an underweight position. Thus, there is likely going to be a fair amount of cash looking for a home. "So," I concluded, "from a big pictures standpoint, we just might see stocks and bond yields rising together for a while."

To which, my friend replied, "Well that would certainly be interesting. But I'm not sure I buy it. Good thing you have risk management systems to fall back on in case your thesis doesn't hold up!"

My response was simple and to the point, "Touché."

Turning to this morning...

Tuesday's optimism has quickly faded today as growth rates in Europe and China were cut by the OECD and IMF respectively. In addition, the OECD said that the ECB would likely need to cut rates at its June meeting. European bourses are down hard across the board and U.S. futures are following suit.

Follow Me on Twitter: @StateDave

-----------------------------

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

Posted to Investing 101 on May 29, 2013 — 8:05 AM
Comments ({[comments.length]})
Sort By:
Loading Comments
No comments. Break the ice and be the first!
Error loading comments Click here to retry
No comments found matching this filter
Want to add a comment? Take me to the new comment box!