PHONE: 414-223-1099 TOLL-FREE: 1-800-236-1096

Which market is right?

wx vane

By Bob Landaas

Either the bond market is wrong or the stock market is wrong.

The bond market is rallying a year after the sell-off last May, when Ben Bernanke testified in front of Congress. Then chairman of the Federal Reserve, Bernanke talked about tapering, reducing bond buying. Then bonds went into a tailspin. A lot of analysts felt that the selling got a little too carried away.

Last fall, the newspapers and the magazines were loaded with articles saying that the time for bonds is past, that interest rates have nowhere to go but up.

When the Fed finally got around to tapering in December, bonds rallied. Typically, bonds rally when it’s perceived that economic growth is decelerating, when people feel the future isn’t good so they go into fixed income.

On the other hand, the Dow has held its own so far this year. The Nasdaq is up. The S&P has advanced 4% through May.

Usually, one is wrong. My guess is that the bond market is wrong. It didn’t know how to react to tapering.

Usually, the stock market is a better leading indicator. My guess is that investors are so starved for yield that they’ve been pouring into bonds inappropriately. My guess is that, of the two, the bond market is going to be the loser.

The point is that the stock market has weathered the storm of the slowdown in China. That’s a big deal, no matter how you try to sugarcoat it:

  • China came out with a manufacturing report in January that was the worst in seven months.
  • They came out with an export number in February, down 18%. That was truly awful.
  • We found out recently that capacity utilization in China is now 60%. What that means is 40% of all plant and equipment is sitting idle in China.

In the United States, we’re at almost 79% of capacity. You never hit 100%. Usually, the bottlenecks in the supply chain are created around 81% of capacity.

But it tells you that there’s just not a lot of pricing pressure out there with a world that’s awash in excess capacity. I think the Fed move toward higher interest rates could take a while.

What’s interesting is that we started the year with the 10-year at 3%. We thought we were going north from there, and then we fell below 2.5%. Bonds, for most investors, have made more than stocks this year.

I would doubt that you would have had many takers on that bet earlier in the year. And it’s unlikely that interest rates are going to go down any more. In fact, most of the pros are forecasting that the 10-year will head back up to 3% by next year as the economy continues to gain traction following the setbacks from this past winter’s severe weather.

But it’s interesting to see the dynamics of the markets. It underscores the whole concept that there’s not a lot of measurable inflation out there. It could be years before the Fed raises rates.

If you think back to 2011, that was when the U.S. credit rating was lowered just a tad. A lot of people talked about how interest rates were going to take off after that. They never did.

The same thing in 2012.

The same thing in 2013 into this year.

A lot of the pros were forecasting that the rates by the Fed would go up later this year. Now, next to no one is thinking it will happen even next year. So we keep postponing the point at which the Fed is going to raise rates. And that just builds underlying support for the stock market.

Think back in the mid 1990s when they talked about the Goldilocks economy – not too hot, so that interest rates would go way up; not too cold, so that companies would remain profitable. That just-about-right economy moved the markets for years to higher levels before the end, at Y2K.

I like the fact that the economy is nowhere near overheating. It gives us the confidence to be able to predict that interest rates won’t go up enough to really derail the stock market. Meanwhile, bond investors with average durations around four and five years should hold up well.

I think this will unwind. And that’s healthy. You want that, because you’d rather have the stock market do well than the bond market.

Bob Landaas is president of Landaas & Company.

(initially posted June 5, 2014)

More information and insight from Money Talk

Money Talk Videos

Follow us on Twitter.

Landaas newsletter subscribers return to the newsletter via e-mail.

Text Size:  A  A  reset

No client or potential client should assume that any information presented or made available on or through this website should be construed as personalized financial planning or investment advice. Personalized financial planning and investment advice can be rendered only after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures.
Landaas & Company performs investment advisory services only in those states where it is licensed, or excluded or exempted from state investment advisor licensing requirements. All responses to inquiries made by prospective customers to this internet site will not be made absent compliance with state investment advisor and investment advisor rep licensing requirements, or applicable exemptions or exclusions from licensing.
Please contact the firm for more information.

Powered By: mindspike design
© 2024 Landaas & Company