Dear Bernanke - You Can't Have Your Cake And Eat It Too

Includes: SPY, TLT
by: John Rothe

The U.S. stock market continues its euphoric rise into record territory despite continuing weakness in economic data. Recent comments from Federal Reserve Board Chair, Ben Bernanke, indicating that the Fed does not have a predetermined plan to stop its stimulus plan has investors increasing their allocations to equities.

However, 30 year U.S. Treasury Bond prices continue to fall causing long term interest rates to rise. Some of the decline in bond prices can be attributed to profit taking and/or investors shifting into equities, it should be noted that unlike equity markets, long term bond prices have failed to rally after comments from Ben Bernanke. This may be an indication that bond investors are still worried about the Fed's future plans.

At some point the current disconnect between bond and equity prices will revert to the mean as higher interest rates will have a negative impact on the economy. This will most likely occur in one of two ways:

1) The Fed will increase their purchasing of long term bonds in order to lower long term rates.

2) Equity investors will begin to worry about rising long term rates and shift out of equities.

I believe the Fed is trying to walk a fine line by letting rates rise just enough to cause a minor shift out of equities in order to remove some of the leverage out of equity markets.

As the S&P 500 Index (NYSEARCA:SPY) continues its euphoric rise, investors are "buying the dips" in belief that the Fed will continue its current stimulus policy.

SPX Weekly Chart:

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Source: Riverbend Investment Management

While long term U.S. Treasury bond prices continue to fall and may be headed to levels not seen since 2011.

TLT Weekly:

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Source: Riverbend Investment Management

30 year U.S. Treasury yields are rising, even with an increase in U.S. bond purchases (verses the hinted slowdown in purchases).

This may be an indication that the sell-off in bonds may be more emotional and less logical.

This may cause prices to drop to 2011 levels where technical traders will begin to shift back into bonds.

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Source: U.S. Federal Reserve

Meanwhile, gold (XAU) prices continue to drop. Indicating that investors are not worried about inflation:

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Source: Riverbend Investment Management

Additionally, weakness in copper prices year to date is showing that global growth is not expanding which should keep the Fed from ending their stimulus programs.

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Continued economic weakness is also supported by comments from shipping companies.

FedEx's (NYSE:FDX) 45% drop in 4th quarter profits and an outlook for a 2014 GDP of 2.3% demonstrates that global growth is not expanding.

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Source: CNN

The recent comments from the Fed and the current rise in long term interest rates is a sign that Ben Bernanke may be trying to deflate bubbles that are forming in the economy.

Bernanke's short term objective may be to try to remove some of the leverage in the current market in order to prevent a much larger future stock market drop - while trying to keep the U.S. economy expanding.

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This is still a market being driven by the Fed, and investors need to pay close attention to the Fed's balance sheet to best gauge if Ben Bernanke and company are trying to talk the froth out of the equity markets -- or if they actually believe the U.S. economy is strong enough to expand on its own.

Disclosure: I am long SSO, TBF. 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.