The Pollyanna Stock Market Is Back, But So Are Bonds

Includes: SPY, TLT
by: John Rothe

The Pollyanna stock market is back. After a quick decline, the US equity markets reversed their downtrend and are nearing highs once again.

Investors are still fleeing high-beta stocks for less-volatile sectors, indicating that despite a continuing rise in the market, investors are worried about taking too much risk in their portfolios.

Meanwhile, risk-adverse investors continue to pour money into US Treasuries as the risk of a slowing economy leading to further Fed action becomes a real possibility.

While rates are historically low, they can and may go lower. Japan and Germany, two major influences in the global macro picture, have rates that are currently lower than US Treasuries.

As economic numbers continue to worsen, we believe a great risk/reward opportunity lies in US Treasuries instead of equities.

Lastly, the Federal Open Market Committee (FOMC) meets this week. Investors will be keeping a close eye on any changes in policy stance among members as some believe the Fed should be slowing down its efforts.

US Treasuries

(iShares Barclays 20+ Yr Treasury Bond "TLT")

Our proprietary trading model has given a buy signal.

In addition, the downtrend in prices that has been in place since last summer, seems to have reversed:

Source: Thomson Reuters

Inverse Relationship Of Yield And Price

Investors should understand the inverse relationship between bond yields and bond prices. As yields drop, prices rise.

More and more investors are no longer holding bonds until maturity due to low rates, but are using them as a trading vehicle.

This changes the risk profile of bonds and may lead to more equity-like volatility in fixed income markets as investors try to guess the Fed's next move.

US Vs Germany Vs Japan?

While the yield on 30 Year Treasury Bonds remains low:

Source: Bloomberg

In Germany (Europe's main growth engine) yields are approximately 35% lower - despite being viewed as a potential riskier investment due to problems in Euro countries.

Typically, investors should be rewarded with higher yields for taking more risk:

Source: Bloomberg

And Japan's 30 year yield is 77% lower than US Bonds:

Source: Bloomberg

The Fed Is Stuck

Consumer spending remains volatile and declined in the first quarter - not the sign of a healthy economy.

The US is a consumer-based economy. Without a rising trend in consumption, the Fed must continue its quantitative easing to prevent a further slowdown.

Source: Bureau of Economic Analysis

As US consumer spending continues to slow, the Fed must continue its current monetary program to prevent the US economy from stalling.

Source: dshort

Deflationary concerns will also help Ben Bernanke's argument to keep the current monetary policy in place as other FOMC members may argue otherwise.

Disclosure: I am long TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.