May 18, 2021

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Are Bonds Positioning For Stock Market Weakness?

There are no major events on the economic calendar today and no compelling market drivers this week – at least not for bonds. Stocks, on the flip side, have a profitable season as well as another moment to ponder whether valuations are showing frothy enough growth to warrant a temporary or otherwise retreat. During weeks like this, it’s not uncommon for stocks and bonds to have a more conventional relationship. How much weakness in stocks would it take to make a big impression on bonds? We will see…

Let’s spoil the ending from the start: the correlation between stock prices and bond yields was fleeting at best in 2021, so we probably shouldn’t rely on it for motivating the bond market, even if the past few days have had a more conventional relationship.

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Here’s what happened in the few minutes after taking the previous graph:

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What about it? Shouldn’t stocks and bonds move together? The decade before the financial crisis certainly confirmed this. The relationship was not always perfect, but the directional correlation was very reliable.

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Today we are fortunate enough to see this correlation for even a few days. The last notable instance was at the end of March.

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And most of the past 2 months have seen the opposite behavior.

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Part of the problem here is that what most of us perceive to be a normal correlation was largely out of the window after the financial crisis. Fed QE is, after all, a rising tide that is lifting all boats (i.e. bond and stock prices). Another part of the problem is the time frames in focus. The more we zoom in, the easier it is to see different examples of correlation. The more we zoom out, the more things start to align.

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Until we zoom out too far …

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What’s the point of all of this? Yes, there are times when stock and bond yields appear to be falling as a result. There are times when stocks are rising and bond yields seem to be following higher. And yes, there has been a good correlation over the past few days. But the latest correlation is probably best seen as a by-product of an absolutely empty calendar of follow-up events for bonds combined with the earnings season for stocks. After all, it would take a much bigger drop in stocks than we’ve seen so far in 2021 to get the bond market’s attention.