Stocks may have hit all-time highs last week but there is some unsettling action going on outside the scope of equities. And this is in the bond market.
Bond prices and equity prices don’t typically move in the same direction. But they did last week. Momentum stocks regained some of their tarnished luster at the same time that buyers flooded the bond market, pushing bond prices up and yields down.
Remember that as bond prices rise, yields fall. And falling interest rates are not something we typically see in a healthy bull market. But that’s the situation we find ourselves in today, prompting some to question whether this market rally can last.
On the one hand it would be reasonable to expect equities to fall if interest rates continue to drop. On the other hand, the bond rally/interest rate drop could be a short-term phenomenon that lacks the punch to derail this equity bull market.
Perhaps we can attribute some of the bond rally to the weak Q1 GDP number last week, but certainly not all of it. Bonds have been rallying before that number was posted.
Much more likely is that there is a combination of influencing factors, none of which are overly concerning in their own right.
Expectations are for the European Central Bank to ease. Comments from many ECB officials indicated this would be the case later this week. The global bond market has likely moved considerably as a result.
And we shouldn’t overlook supply/demand dynamics either. A note from Deutsche Bank states that Treasury bond issuance is down a massive 59% year-to-date (as compared to last year at this time). The U.S government isn’t the only one that has pulled back debt offerings. Corporate bond offerings and mortgage-backed securities have also fallen.
With less debt in the market to buy, and equities at all time highs, demand for quality bonds is running high, creating a supply shortage.
The Financial Times relayed the message that RBS sees global demand for high-quality bonds hitting $1.2 trillion this year. But actual net supply is far less than that number, coming in at a mere $600 billion.
So what are equity investors to do?
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