To the surprise of most, bonds have rallied while stocks have move sideways. In a week with very little data, and many thinking about an early Memorial Day vacation, the bond/stock tradeoff to be a favorite topic for the punditry.
Prior Theme Recap
Last week I expected a focus on market divergences, especially the decline of small cap stocks. While the financial media also featured news from hedge fund gurus and Fed speakers, the divergence notion was an important theme all week. It will probably continue.
Since I do not regard these divergences as an important leading indicator, the planning was helpful in doing some shopping.
Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the “theme forecast.” I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.
Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
This Week’s Theme
What should we make of the rally in bonds, a surprise to nearly everyone? Does it provide an important signal of weakness in stocks?
It is a complex topic, with many angles.
- It was the contrarian reaction. Ryan Detrick made a timely call using this reasoning. He expects a continued drop in yield. Check out his reasoning!
- The Fed is on a long-term low-rate policy. While this directly affects the short end, it also alters the term structure and therefore the long end. Ben Bernanke has been tipping this to those attending his $250K sessions. (Also here).
- Short covering by everyone who was wrong. (Barron’s)
- Pension plans are locking in safe gains. (See Doug Kass via Josh Brown for this and other ideas)
- The economy is weakening. For the “structural deflation” hypothesis,see here.
- Prices are attractive compared to European bonds. (Gundlach).
- There is less Treasury issuance. (Guggenheim).
For investors trying to make stock/bond asset allocations, the explanation is important. Past speculation (Woe is us! After QE ends, no one will buy US bonds!) has been unhelpful.
As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.
Last Week’s Data
Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
- It is better than expectations.
The Good
There was little news, but it was mostly good.
- Sea containers set another record for growth in April. This is a good trade indicator. See Steven Hansen’s comprehensive analysis and charts at GEI.
- Small business optimism has improved. Dr. Ed Yardeni highlightsthe percentage of those citing “poor sales” and shows the correlation with the unemployment rate.
- Rail traffic strength continues. This is true for all time frames, asSteven Hansen shows in a helpful analysis at GEI.
- Weekly jobless claims hit a seven-year low. Bespoke has a good post and several helpful charts, including this one:
Bespoke has a good post and several helpful charts, including this one:
- Bespoke has a good post and several helpful charts, including this one:WSJ). While some will decry this as subprime 2.0, our scoring is based on whether something is market friendly. The initial impact of this will be positive for home construction and the economy.
- Earnings guidance turned positive. For the last ten quarters – and despite the rally in stocks – a regular feature of earnings season has been a weaker outlook. While forward guidance is not strong, it is finally positive, as noted by Bespoke.
