The Contrary Investing Report
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Is the Bond Market Signaling an Impending Stock Market Collapse?

by Brett on August 11, 2010

Until today, bonds had been rallying in tandem with stocks for the last 3 months.  That’s a bit of a rarity – one that has historically preceded a stock market collapse or two.

A couple of observations here – the first from David Rosenberg, courtesy of Pragmatic Capitalism:

“The yield on the 10-year note hit its nearby peak on April 5, at 4.01%, and has since plunged nearly 120 basis points. Declines of this magnitude very often presage the onset of bear markets and recessions. Typically, equities and then economists are late to the game. Nothing we are seeing is any different from the past, at least on this score. What is key to note is that the bond market is the tail that wags the stock market’s dog — it leads.

The 10-year note yield peaked on May 2, 1990 at 9.09%. By December 12, 1990, the yield was all the way down to 7.91%. The S&P 500 peaked on July 16, 1990, the same month the recession started. So Mr. Bond led both by over two months — the 120 basis point slide in yields by December provided ratification (though there were still some, including Alan Greenspan at the time, who still believed a recession had been averted).

The yield on the 10-year T-note peaked at 6.79% on January 20, 2000 — the stock market peaked less than eight months later on September 1. By November 28, 2000, the yield had plunged to 5.59% — down 120 basis points (as is the case today), again providing ratification that we were not heading into some routine soft patch. Indeed, the recession started in March 2001, so the bond market again played the role of the real leading economic indicator, not the stock market.

And next, Jeff Clark wonders if it’s 1987 all over again:

The long bond is up 20% since April. Investors are currently willing to lend money to the U.S. Treasury for 30 years for just 4%.

Usually, as stock prices go up, bond prices fall. Investors shun the safety and security of the Treasury market in favor of potentially higher returns in stocks. There have been, however, a few notable times in history when it didn’t quite work this way.

Stocks and bonds rallied together and peaked at the same time in March 2000. They also rallied together in the spring and summer of 1987. Neither of those was a good time to be overly exposed to the stock market.

Now is probably not a good time, either.

Because I believe we’re in a deflationary period, my bet would also be on stocks breaking down, rather than bonds.

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