Friday, July 15, 2016

We hold these truths to be self-evident...

that stocks and bonds cannot correlate forever.

Okay, so I'm paraphrasing a bit.  However, we are in the midst of a historic sequence in the markets which either:

a) will mean that every basic principal of investing is no longer valid or

b) will eventually reverse course

The premise that I'm referring to is that equities (stocks) are bought because they are a bet on future growth prospects.  You buy stocks when you think there will be increasing income earned by these stocks which will be reinvested to grow the business or returned to shareholders in the form of dividends.

You buy US government bonds as a safe haven in the storm when the economy is sending warning signs of recession and you are focused on capital preservation.

Well, the yield (interest rate) on the 10 year US Treasury bond fell to it's lowest level ever last week.  Not the lowest level of the decade or the past 20 years......EVER. 

This implies to those that studied ECON 101 that the prospects for the US economy are not very strong (the previous low was set during a period from 1940-45, the heart of the Great Depression).

Okay, but stocks also surged back to record levels in the US this week so clearly the prospects for earnings and dividends must be soaring as well, right?

Notice how these three measures moved in unison until the February stock market rescue.  Since that time earnings expectations for the S&P 500 have continued to tumble while stocks have resumed their meteoric rise. 

I often lament the loss of fundamental focus in the markets but this chart really conveys that message better than anything I could say or write.  While the traditional media likes to report to you the daily moves in the S&P and the Dow know that those numbers no longer correlate to what is happening in the real world. 

So, the question we have in front of us is - are bonds correct in telling us the global economy is unraveling or are stocks correct in telling us that everything is awesome? 

I'll try to offer some answers in a coming post.

Cheers!

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