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The Bond Market Is Waving a Big Red Flag For Stock Investors

Plunging yields on U.S. government bonds across the maturity spectrum in January are signaling slowing economic growth - and thus bad news for the stock market. “There is obviously a separation between where the equity market sees the world and where the bond market sees the world,” as Kevin Giddis, head of fixed income at investment banking and wealth management firm Raymond James Financial, told The Wall Street Journal.

The table below tracks the movement of the S&P 500 Index (SPX) from the all-time record high set in intraday trading on Sept. 21, 2018, down to the recent low set in intraday trading on Dec. 26, 2018, and then up to the close on Feb. 1, 2019. The question is how long this rally can last.

How Long Can The Stock Rally Last?

  • Top to Bottom Plunge in 2018: -20.2%
  • Rally Since 2018 Bottom: +15.3%

Source: Yahoo Finance

Significance For Investors

To be sure, the recent rally in stocks has persuaded many investors that the risk of a bear market has fallen dramatically. But should the views of both equity and debt investors move toward a pessimistic consensus on the path of the economy, stock prices are likely to head downwards once again, accompanied by increased volatility. "The question for the stock market is, are we bouncing back from oversold levels in December, or is it an actual rally?" says Darrell Cronk, president of the Wells Fargo Investment Institute, in remarks to the Journal.

The yield on the 10-Year U.S. Treasury Note is a benchmark, or point of reference, which is to used to set a variety of lending rates, ranging from home mortgages to student loans, among others. The T-Note yield has fallen for three consecutive months, its longest downtrend since the summer of 2015, the Journal notes. Back then, rising fears about decelerating GDP growth in China and across the world sent stock U.S. prices plunging.

Declines in the housing market, manufacturing activity, and consumer confidence are among the recent negative economic developments. On the other hand, the U.S. added 304,000 more jobs in January, far more than economists predicted, and economists surveyed by the Journal expect U.S. GDP to continue growing in 2019, at a 2.2% pace.

The jobs figure was 77% higher than the number predicted by economists, per a MarketWatch poll. Yields on 2-year, 10-year, and 30-year U.S. Treasury notes and bonds moved up slightly in response, but were still down for the week. Economists generally do not believe that the Federal Reserve will reverse the more cautious, or dovish, approach to future interest rate hikes that it announced last week, the same article indicates.

Barron's columnist James Grant also sees danger ahead longterm. "A new, perhaps lengthy bond bear market, with lots of volatility along the way," he says. The rapidly rising U.S. national debt, at $22 trillion and "with another $1 trillion looming in this ostensibly prosperous fiscal year alone," is a big reason why Grant anticipates that yields have bottomed out and are set for a decades-long secular uptrend. "Cheap capital built leveraged, loss-making businesses," he notes, asking, rhetorically, "How will these bull-market creations fare in the face of higher rates, tighter credit, and cyclically stunted revenue growth?"

Looking Ahead

If the bond market is correct, equity investors should brace for declining economic growth and corporate earnings. But the news may not be much better longer term. A reversal in the secular trend of interest rates from down to up also could be a bearish development for the markets.