Bonds are flashing a warning sign for stocks

US stock markets have had a strong 2016 and a particularly good six weeks since the US election. Both the S&P 500 and Nasdaq have posted gains of about 5% since election night, and the Dow Jones Industrial Average has tacked on 8% and is approaching the 20,000 mark.

Analysts across Wall Street are predicting more of this in 2017, even if at a slower pace. Business Insider recently looked at the calls from nine Wall Street pros, all of whom saw the S&P 500 climbing in 2017.

While the stock market has been on fire, the bond market has been under significant pressure. That’s not an accident: Analysts say there’s a rotation underway as expectations for inflation make bonds less attractive relative to stocks.

“Last week’s fund flow data may go down in history as the first real indication of the switch from bonds to equities,” Sean Darby, the chief global equity strategist at Jefferies, wrote in a note to clients last month.

But the selling in bonds could now be starting to undercut the stock market’s appeal.

As the so-called bond vigilantes have come out of the woodwork — speculating that Trump’s protectionist trade policies and plans for $550 billion of infrastructure spending will bring back inflation to the US — aggressive selling has pushed bond yields up sharply, with the yield on 10-year Treasurys crossing the 2.60% threshold on Thursday morning.

And that should be of particular interest to investors in US stocks, according to a note released by Societe Generale’s Cross Asset Allocation team on November 18. The team looks at the relative value of one asset over another — and after bond prices have fallen so far, so fast, stocks are starting to look pricey compared to bonds.

The team wrote that over the past 16 years there have been 11 instances in which Treasury yields rose about 120 basis points off their lows (the 10-year bottomed at 1.36% on July 8, and it’s up 124 basis points right now). In those instances, stocks gained an average of 6%.

That’s already happened since the election, and stocks are now at a level where SocGen says they’re “rich” relative to bonds.

So there’s that.

 

Source: BusinessInsider