Here’s What The Treasury/Stock Relationship Is Telling Us
Typically, equities and
treasuries are inversely related, that is, they move in opposite directions.
When the economic picture is looks bright, equities move higher due to higher
expectations for profits, while Treasuries move lower in anticipation of Fed
tightening and higher inflation. As a result, many equity investors reference
government securities as an indicator of what direction stocks are going to do.
However, the negative correlation between these two instruments has broken down
over the past several weeks, and Treasuries and stocks have been moving higher
together. But this change doesn’t necessarily mean that equity investors should
ignore Treasuries. In fact, equity bulls should be paying closer attention now
more than ever.
During the final stages of an economic recession,
it is not unusual for Treasuries and equities to move higher. The reason is that
stocks are forward looking and tend to move higher at the end of recessionary
periods as investors purchase equities in anticipation of stronger growth to
come — despite the lack of confirmation in data releases, which are backward
looking. At the same time, Treasuries also move higher during this period
as a result of falling inflation — which is very common during the final stages
of recession. In fact, during the last three months of the last eight
recessions, the S&P
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PowerRating) has gained an average of 12.8%, while the
yield on the 10-year note
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PowerRating) has dropped an average of 57 basis
points (Treasury prices are inversely related to their yields).
Although the last official recession ended in
December of 2001, when the economy contracted for two consecutive quarters, the
manufacturing sector has continued to contract, while the rest of the economy
has puttered along in a very anemic recovery — if you can call it that. As a
result, stocks and bonds are only now acting as though we are emerging from a
recession.