LOOKING FOR A U-TURN
Stocks are leading bonds by a comfortable margin this year, but Mr. Market may be plotting for a reversal of fortunes.
The motivation for considering such an apostasy in a world that holds equities near and dear comes by way of recent action in the 10-year Treasury Note’s yield, which dipped below 4.80% yesterday for the first time since March 29. Since June 28, the recent top in the price of money on the benchmark Treasury, the 10-year’s yield has dropped more than 40 basis points.
The trend in yield is down, which means demand for bonds is up. Nonetheless, the surge of buying fixed-income securities of late still hasn’t reversed the edge that stocks hold over bonds this year, but the odds for a turnaround are looking better, or so we’re told. For the moment, however, the S&P 500 is still up by 5.3% this year on a total return basis through yesterday, while the Lehman Brothers Aggregate Bond Index has climbed only 1.7%.
The catalyst behind the notion that bonds may wind up the winner in the two-legged asset-class performance race for 2006 is the expectation that the economy’s slowing. Some are even going so far as to predict that a recession is coming. Nouriel Roubini, an economics professor at New York University, on Sunday wrote on his blog that the “U.S. economy will fall into a recession by early 2007.” Such talk is inspiring the bond market because it implies that interest rates will fall, delivering big gains to fixed-income securities along the way. If so, stocks would take a hit, or so the history from past recessions suggests.
Recent data has provided a degree of support for the economy-is-slowing view, and as a result the bond bulls have become emboldened for their cause by backing up their predictions with cash. Indeed, the only trend that impresses Wall Street is one backed by money, and so the rush to Treasuries of late has more than a few financial types sitting up and paying attention.
But despite the gush of bond buying in recent weeks, the road to relative outperformance is still booby trapped with anti-clarity cluster bombs. Chicago Fed President Michael Moskow yesterday tried to throw some cold water on the bubbling expectations in the bond market by warning that the Federal Reserve may still have more rate hikes up its sleeve. Yes, the Fed ended its two-year campaign of tightening at its last meeting on August 8, but Moskow (who’s not a voting member of the FOMC) said yesterday that higher rates may yet be required for slowing inflation’s upward momentum of late.