SOMETHING HAS TO GIVE

Three commentators discuss the same phenomenon:

OVER THE PAST DECADE, stock and bond prices have generally moved in opposite directions, meaning that share prices and bond yields have moved together, both higher and lower.(…)

This important relationship held true this year until June, when bond yields peaked. One month later, as yields moved lower, stocks began their current leg up.(…)

Given their relationship at major turning points over the years, something is not quite right. And when it comes to trusting bonds or stocks for the correct "opinion," history would suggest that it’s usually better to go with bonds.(…)

One part of the bond market caught my eye this week. The yield on two-year Treasury notes fell nearly 40% to an unreal low of 0.67% and is just a hair from its generational low of one year ago.

[Getting Tech chart]


This is important for two reasons. The first is that one year ago, the financial markets were nearly frozen and investors looked for the safest places possible to park their money. Treasury securities with short maturities were the only assets that were holding their value and demand to own them pushed prices up and yields way down.

The second reason is that the yield on the two-year note joined three-month bills in approaching zero again. Longer dated Treasury yields, from five years to 30 years, are not even close to reaching respective 2008 lows and that suggests that some money is moving towards an extreme safety position again.(…)

Full Barron’s article

And David Rosenberg

The U.S. 10-year Treasury note yield gapped above the 50-day moving average yesterday. In the past six months we have been in a most unusual backdrop: bond prices up, equity prices up, oil prices up and gold prices up. Looking back at the historical record, this is what you call a 1-in-15 event. In other words, not normal, and something has to give.

In the past, it has been Mr. Bond, shaken and stirred, that has been the arbiter of realigning the asset mix. (…)

The odd man out here is clearly the bond, but if yields head back up to 4% (about 50% of the rally in the 10-year note has just been retraced in this recent spasm in yield), expect a countertrend rally in the U.S. dollar over the near-term and a giveback in all these risky assets that all of sudden become 90% correlated with the greenback.

As for the vast amount of supply we mentioned above, well, the U.S. Treasury is going to auction — get this — $105 billion in Treasury bills and notes next week. Talk about choking on the wishbone. This fiscal largesse may come at a pretty big cost and aside from a countertrend rally in the U.S. dollar (as Mr. Trichet is pushing for) a further yield spasm in the Treasury market at a time when the economy is still struggling (ISM services back below 50 — that is not good) could well be enough to upset the equity market apple cart; just as investors are closing their books as the year draws to a close. Buying some protection, especially now that it is cheap, may not be a bad idea.

Tony Boeckh adds

The last nine months have been a remarkable period in that equities, gold and corporate bonds have all appreciated by double digits. This has only occurred on two other occasions in the last 50 years. Typically, equities perform best during periods of low and stable inflation, like the current environment. Gold (and other commodities) performs best during inflationary periods and when the dollar is weak, while government bonds tend to outperform during periods of deflation and risk aversion. The current, unusual dynamic where almost everything has gone up together cannot last forever.(…)

The current environment diverges from the typical cycle in that easy policy is not translating into domestic consumer or business credit expansion.

 

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