Bonds Diverging From Stocks: What Gives?

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 |  Includes: TBT
by: Stock Traders Daily

Sometimes the bond market provides a read on the economy that is opposite of what the stock market offers. Today's environment is exactly like that, and even though the stock market has rallied hard off of its January lows the bond market has not retreated at all. In fact, as investors poured money into aggressive equities, the safe haven that is U.S. Treasury bonds was also bought aggressively.

Recent news has uncovered that China sold U.S. Treasury bonds aggressively in light of the expected tapering from the FOMC, and reasonably that could have caused bond prices to be depressed, but something more important may be happening behind the scenes.

Specifically, the economy may be much weaker than most people believe.

My macro economic analysis is called the Investment Rate, and it tells us that the underlying economy is indeed much weaker than the fabricated growth in our current environment suggests. It also tells me that the economy will eventually revert back to that naturally weak condition once the combined efforts of the U.S. treasury and Federal Reserve begin to drain liquidity from the economy. That is only a few months away, but as the real net capital infusions diminish the economy itself already seems to be taking notice.

If nothing more, the smarter money, which has historically been in the bond market, is more interested in safer investments than it has been in a long while. Even though the stock market is pressing all time highs as it bounces off of its January low, bond market investors are buying actively.

I watch the double short ETF for the long-term U.S. Treasury bond closely (TBT), and although TBT has not broken our longer term support line yet (TBT Report), it has faltered from a successful test of longer term support recently. Initially, that trade began to work nicely because TBT bounced off of longer term support in began to make positive headway, but the inability of that ETF to continue to move higher presents red flags that are directly in line with the concerns offered above.

The bond market seems to be telling us that more risk exists than those that the stock market is observing. Fast money is obviously playing a role in the stock market, buying the dips has been the name of the game for about a year, which is a lifetime to the nearsighted stock market, but the more prudent investor is moving to more safe assets, and surprisingly buying long-term U.S. treasury bonds.

Finding value in long-term U.S. treasury bonds with interest rates this low is tough for some people to do, but when the real underlying economy as that is defined by the Investment Rate is revealed and the fabricated growth that has been asking that natural weakness is removed those investors who are prudent and diligent begin to understand that the best place for their money might actually be in an asset class that provides protection without much return.

Although I believe in proactive trading strategies that can make money in both directions, it is clear that some investors are taking positions in long-term treasury bonds because they do not trust the economic environment that lies ahead as tapering continues, which will eventually lead to a drain on liquidity in the US economy. I can't blame them, because my observation tells me it is just a matter of time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: By Thomas H. Kee Jr for Stock Traders Daily and neither receives compensation from the publicly traded companies listed herein for writing this article.