Stocks Up, Bonds Up. Which Market Is Wrong?

Nine weeks of gains for U.S. stocks. Credit for the rally again goes to “trade hopes” (the media is at a loss in explaining this rally). But in reality, this is a momentum squeeze trade, killing all those who assumed a second down-leg in stocks would follow the December crash. Equities are getting more over-bought by the day and upside exhaustion signals are apparent. Nonetheless, we have not seen a full capitulation of investors who panicked in December. The pain trade remains to the upside, but for investors who can take an intermediateterm position, getting short at these levels should payoff later this year.

Macro data this week continued to deteriorate.

  • Orders for long-lasting goods rose 1.2% in December vs a forecast for +1.4%. Orders for commercial planes surged 28% in December and bookings for new cars and trucks climbed 2.1%. Beyond that the industrial sector was weak. A key measure of business investment, known as core orders, also slipped 0.7% in December. We judge the durable goods report to be neutral, at best, as a sign of economic health.
  • The Philadelphia Fed manufacturing index in February dropped sharply into negative territory. The index fell to a seasonally adjusted reading of -4.1 from 17 in the prior month (a reading of 14 was expected). This is the first negative reading since May 2016. Any reading below zero indicates worsening conditions. Below the headline, the indexes for new orders and shipments dropped sharply into negative territory. Falling new orders and shipment, from our point of view, is not a sign of future economic strength.
  • Existing home sales, the only housing data that was not delayed due to the government shutdown, fell for a third straight month to a 3-year low. Sales of previously-owned homes were even lower (by – 1.2%) than the 3-year low they hit in December. They were -8.5% lower than a year ago. First-time buyers haven’t made any progress, and even took a step back in January, making up 29% of all transactions during the month, well below their long-term average 40% share. The slowing housing market may be due to the change in the tax law, which reduced the tax-advantage of mortgages, especially in high-tax states.
  • Markit said its U.S. manufacturing purchasing managers’ index fell to 53.7 in February, a 17-month low, from 54.9 last month. The Markit services PMI, however, accelerated in January to 56.2 from 54.4.
  • The leading economic index slipped -0.1% in January. However, three of the 10 components — building permits and new orders for consumer and capital goods — were missing due to the 35-day partial federal shutdown. Given the slowing housing data and falling factory orders (above), our guess is that the LEIs may have been even more negative.

The more economic data-sensitive bond market is picking up on these signs of a slowing economy. In this Commentary, we look at the rather unusual dual strength in the U.S. stock market along with the bond market.

Risk Assets Moving With Safe-Havens

Since the December 24 low, the S&P 500 has risen +18.8% peak-to-trough. Over the same period the U.S. 30- Year Government bond (TLT) is also positive +0.69%. Going back to the November lows on bonds, the TLT is up almost +10%. Gold is up +5% from the December 24 low in stocks and the yellow metal is up over +10% from the November lows. So investors have been making money in both safe-haven and risk assets. This is an anomaly. Gold and T-bonds will not continue to hold up if the U.S. stock market is set to retake all-time highs. Or conversely, if Gold and T-bonds keep moving higher, the stock market rally will become even more incongruous. We assess below the causes for the rallies in risk assets and safe havens. We then propose our thoughts on what might end the rallies in each asset.

Stocks have clearly been rallying on the Federal Reserve’s policy capitulation, as well as hopes that the Trade War will be resolved. While the rally in stocks started on December 26, before the Jerome Powell speech in early January in which he re-emphasized patience in future rate hikes, the majority of equity gains have come on the Fed’s policy reversal. If equity markets are back to gaming the Fed, which appears to be the case, the question is, “to what level will the Fed back the markets?” Most market observers recognize that the Fed has two official objectives (low inflation and full employment) and one unofficial objective (financial market stability, ie: a stable S&P 500). A stable-to-rising S&P 500 may be consistent with the full employment goal, but at some point a rising S&P 500 will correlate with higher inflation in the economy. In other words, the Fed is doing a balancing act between keeping inflation expectation in check while preventing the bubble that THEY CREATED in equites from popping.

Equites will not rise forever on news that the Fed is friendly – all news eventually gets fully priced. A resolution to the Trade War is nothing more than a return to the status quo. Our worry for equities is that the weight of the negative macro data incites investors to begin pricing in a recession risk again. A second, worry (which goes along with the recession scenario) is that investors begin to believe again in the reality peak earnings. There will be no more monetary or fiscal stimulus this cycle to support earnings (the next monetary policy stimulus – QE – will come after the next bear market is well underway).



Bonds have been rallying since November on the weak macro data. Indeed, the bond market has begun pricing in the risk of recession. The solidity of bonds since the stock market rally is due to the reversal of the Fed. Rates are done rising – bond prices have put in a bottom. Barring another up-turn in the economy in the 10th year of this economic expansion, or the Fed re-starting its rate hikes, it’s hard to foresee bonds moving much lower from here.



Gold rallying with stocks is also a curiosity. Latent inflation worries, geopolitical risks, and anticipation of recession are all factors which may continue to drive gold higher. Given the historical 30-year correlation coefficient between stocks and gold is negative. Investors looking forward need to be sellers of ether the S&P 500 or gold.




The rally in risk assets and safe-havens has continued too long. One market will be right in 2019 and the other market will be wrong. As long as macro data keeps coming in weak, we’ll place our chips on the bond market being right.


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